For the quarterly period ended March 31, 2007
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended March 31, 2007

 

OR

 

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

 

For the Transition Period from              to             

 

Commission File Number 001-16707

 


 

Prudential Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

New Jersey   22-3703799

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

 

751 Broad Street

Newark, New Jersey 07102

(973) 802-6000

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

 


 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x                            Accelerated filer ¨                            Non-accelerated filer ¨

 

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

 

As of April 30, 2007, 463 million shares of the registrant’s Common Stock (par value $0.01) were outstanding. In addition, 2 million shares of the registrant’s Class B Stock, for which there is no established public trading market, were outstanding.

 



Table of Contents

TABLE OF CONTENTS

 

             

Page

Number


PART I

  FINANCIAL INFORMATION     
   

Item 1.

  

Financial Statements:

    
        

Unaudited Interim Consolidated Statements of Financial Position as of March 31, 2007 and December 31, 2006

  

1

        

Unaudited Interim Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006

  

2

        

Unaudited Interim Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2007

  

3

        

Unaudited Interim Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006

  

4

        

Notes to Unaudited Interim Consolidated Financial Statements

   5
        

Unaudited Interim Supplemental Combining Financial Information:

    
        

Unaudited Interim Supplemental Combining Statements of Financial Position as of March 31, 2007 and December 31, 2006

  

28

        

Unaudited Interim Supplemental Combining Statements of Operations for the three months ended March 31, 2007 and 2006

  

29

        

Notes to Unaudited Interim Supplemental Combining Financial Information

  

30

   

Item 2.

  

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

  

32

   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   97
   

Item 4.

  

Controls and Procedures

   97

PART II

 

OTHER INFORMATION

    
   

Item 1.

  

Legal Proceedings

   98
   

Item 1A.

  

Risk Factors

   98
   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   99
   

Item 6.

  

Exhibits

   99

SIGNATURES

   100

 

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FORWARD-LOOKING STATEMENTS

 

Certain of the statements included in this Quarterly Report on Form 10-Q, including but not limited to those in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as “expects,” “believes,” “anticipates,” “includes,” “plans,” “assumes,” “estimates,” “projects,” “intends,” “should,” “will,” “shall” or variations of such words are generally part of forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future developments and their potential effects upon Prudential Financial, Inc. and its subsidiaries. There can be no assurance that future developments affecting Prudential Financial, Inc. and its subsidiaries will be those anticipated by management. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties, and there are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including, among others: (1) general economic, market and political conditions, including the performance and fluctuations of stock, real estate and other financial markets; (2) interest rate fluctuations; (3) reestimates of our reserves for future policy benefits and claims; (4) 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; (5) changes in our assumptions related to deferred policy acquisition costs, valuation of business acquired or goodwill; (6) changes in our claims-paying or credit ratings; (7) investment losses and defaults; (8) competition in our product lines and for personnel; (9) changes in tax law; (10) economic, political, currency and other risks relating to our international operations; (11) fluctuations in foreign currency exchange rates and foreign securities markets; (12) regulatory or legislative changes; (13) adverse determinations in litigation or regulatory matters and our exposure to contingent liabilities, including in connection with our divestiture or winding down of businesses; (14) 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; (15) ineffectiveness of risk management policies and procedures in identifying, monitoring and managing risks; (16) effects of acquisitions, divestitures and restructurings, including possible difficulties in integrating and realizing the projected results of acquisitions; (17) changes in statutory or U.S. GAAP accounting principles, practices or policies; (18) changes in assumptions for retirement expense; (19) Prudential Financial, Inc.’s primary reliance, as a holding company, on dividends or distributions from its subsidiaries to meet debt payment obligations and continue share repurchases, and the applicable regulatory restrictions on the ability of the subsidiaries to pay such dividends or distributions; and (20) risks due to the lack of legal separation between our Financial Services Businesses and our Closed Block Business. Prudential Financial, Inc. does not intend, and is under no obligation, to update any particular forward-looking statement included in this document. See “Risk Factors” included in the Annual Report on Form 10-K for the year ended December 31, 2006 for discussion of certain risks relating to our businesses and investment in our securities.

 

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Throughout this Quarterly Report on Form 10-Q, “Prudential Financial” and the “Registrant” refer to Prudential Financial, Inc., the ultimate holding company for all of our companies. “Prudential Insurance” refers to The Prudential Insurance Company of America, before and after its demutualization on December 18, 2001. “Prudential,” the “Company,” “we” and “our” refer to our consolidated operations before and after demutualization.

 

PART I—FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

PRUDENTIAL FINANCIAL, INC.

Unaudited Interim Consolidated Statements of Financial Position

March 31, 2007 and December 31, 2006 (in millions, except share amounts)

 

     March 31,
2007


    December 31,
2006


 

ASSETS

                

Fixed maturities:

                

Available for sale, at fair value (amortized cost: 2007—$159,534; 2006—$158,828)

   $ 163,605     $ 162,816  

Held to maturity, at amortized cost (fair value: 2007—$3,407; 2006—$3,441)

     3,440       3,469  

Trading account assets supporting insurance liabilities, at fair value

     14,223       14,262  

Other trading account assets, at fair value

     2,119       2,209  

Equity securities, available for sale, at fair value (cost: 2007—$7,076; 2006—$6,824)

     8,454       8,103  

Commercial loans

     26,137       25,739  

Policy loans

     8,971       8,887  

Securities purchased under agreements to resell

     113       153  

Other long-term investments

     5,234       4,745  

Short-term investments

     4,964       5,034  
    


 


Total investments

     237,260       235,417  

Cash and cash equivalents

     6,808       8,589  

Accrued investment income

     2,196       2,142  

Reinsurance recoverables

     2,021       1,958  

Deferred policy acquisition costs

     11,059       10,863  

Other assets

     17,946       17,834  

Separate account assets

     181,618       177,463  
    


 


TOTAL ASSETS

   $ 458,908     $ 454,266  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

LIABILITIES

                

Future policy benefits

   $ 107,234     $ 106,951  

Policyholders’ account balances

     80,690       80,652  

Policyholders’ dividends

     4,032       3,982  

Reinsurance payables

     1,472       1,458  

Securities sold under agreements to repurchase

     9,798       11,481  

Cash collateral for loaned securities

     6,234       7,365  

Income taxes

     3,212       3,108  

Securities sold but not yet purchased

     307       277  

Short-term debt

     13,934       12,536  

Long-term debt

     11,830       11,423  

Other liabilities

     15,011       14,678  

Separate account liabilities

     181,618       177,463  
    


 


Total liabilities

     435,372       431,374  
    


 


COMMITMENTS AND CONTINGENT LIABILITIES (See Note 9)

                

STOCKHOLDERS’ EQUITY

                

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

     —         —    

Common Stock ($.01 par value; 1,500,000,000 shares authorized; 604,900,637 and 604,900,423 shares issued as of March 31, 2007 and December 31, 2006, respectively)

     6       6  

Class B Stock ($.01 par value; 10,000,000 shares authorized; 2,000,000 shares issued and outstanding as of March 31, 2007 and December 31, 2006, respectively)

     —         —    

Additional paid-in capital

     20,701       20,666  

Common Stock held in treasury, at cost (139,303,681 and 133,795,373 shares as of March 31, 2007 and December 31, 2006, respectively)

     (7,757 )     (7,143 )

Accumulated other comprehensive income

     692       519  

Retained earnings

     9,894       8,844  
    


 


Total stockholders’ equity

     23,536       22,892  
    


 


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 458,908     $ 454,266  
    


 


 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Operations

Three Months Ended March 31, 2007 and 2006 (in millions, except per share amounts)

 

     Three Months Ended
March 31,


 
         2007    

       2006    

 

REVENUES

               

Premiums

   $ 3,559    $ 3,452  

Policy charges and fee income

     785      664  

Net investment income

     2,991      2,747  

Realized investment gains, net

     420      175  

Asset management fees and other income

     1,066      812  
    

  


Total revenues

     8,821      7,850  
    

  


BENEFITS AND EXPENSES

               

Policyholders’ benefits

     3,685      3,479  

Interest credited to policyholders’ account balances

     843      623  

Dividends to policyholders

     711      623  

General and administrative expenses

     2,153      2,158  
    

  


Total benefits and expenses

     7,392      6,883  
    

  


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

     1,429      967  
    

  


Income tax expense

     424      279  
    

  


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

     1,005      688  

Equity in earnings of operating joint ventures, net of taxes

     77      51  
    

  


INCOME FROM CONTINUING OPERATIONS

     1,082      739  

Income (loss) from discontinued operations, net of taxes

     38      (6 )
    

  


NET INCOME

   $ 1,120    $ 733  
    

  


EARNINGS PER SHARE (See Note 6)

               

Financial Services Businesses

               

Basic:

               

Income from continuing operations per share of Common Stock

   $ 2.14    $ 1.42  

Income (loss) from discontinued operations, net of taxes

     0.08      (0.02 )
    

  


Net income per share of Common Stock

   $ 2.22    $ 1.40  
    

  


Diluted:

               

Income from continuing operations per share of Common Stock

   $ 2.10    $ 1.39  

Income (loss) from discontinued operations, net of taxes

     0.08      (0.01 )
    

  


Net income per share of Common Stock

   $ 2.18    $ 1.38  
    

  


Closed Block Business

               

Basic and Diluted:

               

Income from continuing operations per share of Class B Stock

   $ 39.00    $ 19.50  

Income from discontinued operations, net of taxes

     1.00      —    
    

  


Net income per share of Class B Stock

   $ 40.00    $ 19.50  
    

  


 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statement of Stockholders’ Equity

Three Months Ended March 31, 2007 (in millions)

 

     Common
Stock


   Class
B
Stock


   Additional
Paid-in
Capital


   Retained
Earnings
(Deficit)


    Common
Stock
Held In
Treasury


    Accumulated
Other
Comprehensive
Income


   Total
Stockholders’
Equity


 

Balance, December 31, 2006

   $ 6    $ —      $ 20,666    $ 8,844     $ (7,143 )   $ 519    $ 22,892  

Common Stock acquired

     —        —        —        —         (749 )     —        (749 )

Stock-based compensation programs

     —        —        35      (27 )     135       —        143  

Cumulative effect of changes in accounting principles, net of taxes

     —        —        —        (43 )     —         —        (43 )

Comprehensive income:

                                                    

Net income

     —        —        —        1,120       —         —        1,120  

Other comprehensive income, net of taxes

     —        —        —        —         —         173      173  
                                                


Total comprehensive income

                                                 1,293  
    

  

  

  


 


 

  


Balance, March 31, 2007

   $ 6    $ —      $ 20,701    $ 9,894     $ (7,757 )   $ 692    $ 23,536  
    

  

  

  


 


 

  


 

 

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Cash Flows

Three Months Ended March 31, 2007 and 2006 (in millions)

 

     2007

    2006

 

CASH FLOWS FROM OPERATING ACTIVITIES

                

Net income

   $ 1,120     $ 733  

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

                

Realized investment (gains) losses, net

     (420 )     (175 )

Policy charges and fee income

     (248 )     (216 )

Interest credited to policyholders’ account balances

     843       623  

Depreciation and amortization, including premiums and discounts

     62       84  

Change in:

                

Deferred policy acquisition costs

     (247 )     (235 )

Future policy benefits and other insurance liabilities

     712       640  

Trading account assets supporting insurance liabilities and other trading account assets

     (52 )     (807 )

Income taxes

     (22 )     631  

Securities sold but not yet purchased

     30       (91 )

Other, net

     (1,087 )     (741 )
    


 


Cash flows from operating activities

     691       446  
    


 


CASH FLOWS FROM INVESTING ACTIVITIES

                

Proceeds from the sale/maturity/prepayment of:

                

Fixed maturities, available for sale

     22,802       22,342  

Fixed maturities, held to maturity

     76       83  

Equity securities, available for sale

     1,650       1,009  

Commercial loans

     1,372       1,068  

Policy loans

     324       299  

Other long-term investments

     293       458  

Short-term investments

     2,451       2,407  

Payments for the purchase/origination of:

                

Fixed maturities, available for sale

     (23,184 )     (22,274 )

Fixed maturities, held to maturity

     (59 )     (257 )

Equity securities, available for sale

     (1,620 )     (1,118 )

Commercial loans

     (1,213 )     (997 )

Policy loans

     (318 )     (326 )

Other long-term investments

     (582 )     (323 )

Short-term investments

     (2,619 )     (2,501 )

Other, net

     201       248  
    


 


Cash flows from (used in) investing activities

     (426 )     118  
    


 


CASH FLOWS FROM FINANCING ACTIVITIES

                

Policyholders’ account deposits

     5,265       4,930  

Policyholders’ account withdrawals

     (5,646 )     (5,137 )

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

     (2,812 )     210  

Cash dividends paid on Common Stock

     (72 )     (44 )

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

     990       (15 )

Common Stock acquired

     (712 )     (604 )

Common Stock reissued for exercise of stock options

     83       50  

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

     1,111       1,132  

Repayments of debt (maturities longer than 90 days)

     (387 )     (223 )

Cash payments to or in respect of eligible policyholders

     —         (92 )

Excess tax benefits from share-based payment arrangements

     60       33  

Other, net

     73       (2 )
    


 


Cash flows from (used in) financing activities

     (2,047 )     238  
    


 


Effect of foreign exchange rate changes on cash balances

     1       (3 )

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (1,781 )     799  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     8,589       7,799  
    


 


CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 6,808     $ 8,598  
    


 


 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements

 

1. BUSINESS AND BASIS OF PRESENTATION

 

Prudential Financial, Inc. (“Prudential Financial”) and its subsidiaries (collectively, “Prudential” or the “Company”) provide a wide range of insurance, investment management, and other financial products and services to both individual and institutional customers throughout the United States and in many other countries. Principal products and services provided include life insurance, annuities, mutual funds, pension and retirement-related services and administration, and asset management. In addition, the Company provides retail securities brokerage services indirectly through a minority ownership in a joint venture. The Company has organized its principal operations into the Financial Services Businesses and the Closed Block Business. The Financial Services Businesses operate through three operating divisions: Insurance, Investment, and International Insurance and Investments. The Company’s real estate and relocation services business as well as businesses that are not sufficiently material to warrant separate disclosure and businesses to be divested are included in Corporate and Other operations within the Financial Services Businesses. The Closed Block Business, which includes the Closed Block (see Note 4), is managed separately from the Financial Services Businesses. The Closed Block Business was established on the date of demutualization and includes the Company’s in force participating insurance and annuity products and assets that are used for the payment of benefits and policyholders’ dividends on these products, as well as other assets and equity that support these products and related liabilities. In connection with the demutualization, the Company has ceased offering these participating products.

 

Basis of Presentation

 

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

 

In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations have been made. All such adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Company’s audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

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, goodwill, valuation of business acquired, valuation of investments including derivatives, future policy benefits including guarantees, pension and other postretirement benefits, provision for income taxes, reserves for contingent liabilities and reserves for losses in connection with unresolved legal matters.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Reclassifications

 

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

 

2. ACCOUNTING POLICIES AND PRONOUNCEMENTS

 

Share-Based Payments

 

 

The Company issues employee share-based compensation awards, under a plan authorized by the Board of Directors, that are subject to specific vesting conditions; generally the awards vest ratably over a three-year period, “the nominal vesting period,” or at the date the employee retires (as defined by the plan), if earlier. For awards granted between January 1, 2003 and January 1, 2006 that specify an employee vests in the award upon retirement, the Company accounts for those awards using the nominal vesting period approach. Under this approach, the Company records compensation expense over the nominal vesting period. If the employee retires before the end of the nominal vesting period, any remaining unrecognized compensation cost is recognized at the date of retirement.

 

Upon the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” on January 1, 2006, the Company revised its approach to the recognition of compensation costs for awards granted to retirement-eligible employees and awards that vest when an employee becomes retirement-eligible to apply the non-substantive vesting period approach to all new share-based compensation awards granted on or after January 1, 2006. Under this approach, all compensation cost is recognized on the date of grant for awards issued to retirement-eligible employees, or over the period from the grant date to the date retirement eligibility is achieved, if that is expected to occur during the nominal vesting period.

 

If the Company had accounted for all share-based compensation awards granted after January 1, 2003 under the non-substantive vesting period approach, net income of the Financial Services Businesses for the three months ended March 31, 2007 and 2006 would have been increased by $2.4 million and $2.9 million, or $0.01 and $0.01 per share of Common Stock, respectively, on both a basic and diluted basis.

 

Accounting Pronouncements Adopted

 

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes,” an Interpretation of FASB Statement No. 109. This interpretation 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 a tax return. The Company adopted FIN No. 48 on January 1, 2007, which resulted in a decrease to its income tax liability and an increase to retained earnings of $61 million as of January 1, 2007.

 

The Company had the following amounts of unrecognized tax benefits as of the date of adoption of FIN No. 48:

 

     Unrecognized
tax benefits


   Unrecognized tax benefits
that, if recognized, would
favorably impact the
effective tax rate


     (in millions)

Amounts related to tax years prior to 2002

   $ 389    $ 389

Amounts related to tax years 2002 and forward.

     175      94
    

  

Total Unrecognized Tax Benefits all years

   $ 564    $ 483
    

  

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The Company classifies all interest and penalties related to tax uncertainties as income tax expense. As of the date of adoption of FIN No. 48, the Company had recorded $23 million in liabilities for tax-related interest and penalties.

 

The Company’s liability for income taxes includes the liability for unrecognized tax benefits, interest and penalties which relate to tax years still subject to review by the Internal Revenue Service (“Service”) or other taxing jurisdictions. Audit periods remain open for review until the statute of limitations has passed. Generally, for tax years which produce net operating losses, capital losses or tax credit carryforwards (“tax attributes”), the statute of limitations does not close, to the extent of these tax attributes, until the tax year in which they are fully utilized. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to our liability for income taxes. Any such adjustment could be material to our results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. The Company does not anticipate any significant changes to its total unrecognized tax benefits within the next 12 months.

 

On January 26, 2006, the Service officially closed the audit of the Company’s consolidated federal income tax returns for the 1997 to 2001 periods. As a result of certain favorable resolutions, the Company’s consolidated statement of operations for the year ended December 31, 2005 included an income tax benefit of $720 million, reflecting a reduction in the Company’s liability for income taxes. The statute of limitations has closed for these tax years; however, there were tax attributes which were utilized in subsequent tax years for which the statute of limitations remains open.

 

In December 2006, the Service completed all fieldwork with regards to its examination of the consolidated federal income tax returns for tax years 2002-2003. The final report was submitted to the Joint Committee on Taxation for their review in April 2007. The statute of limitations for the 2002-2003 tax years expires in 2008. In addition, certain tax years prior to 2002 have tax attributes for which the statute of limitations has not yet closed.

 

The Company’s affiliates in Japan file separate tax returns and are subject to audits by the local taxing authority. For tax years after April 1, 2004 the general statute of limitations is 5 years from when the return is filed. For tax years prior to April 1, 2004 the general statute of limitations is 3 years from when the return is filed.

 

In July 2006, the FASB issued FASB Staff Position (“FSP”) No. 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction,” an amendment of FASB Statement No. 13. FSP No. 13-2 indicates that a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease would require a recalculation of cumulative and prospective income recognition associated with the transaction. FSP No. 13-2 is effective for fiscal years beginning after December 15, 2006. The Company adopted FSP No. 13-2 on January 1, 2007 and the adoption resulted in a net after-tax reduction to retained earnings of $84 million, as of January 1, 2007.

 

In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.” SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS No. 97. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of 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, and is effective for internal replacements occurring in fiscal

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

years beginning after December 15, 2006. The Company adopted SOP 05-1 on January 1, 2007 and the adoption resulted in a net after-tax reduction to retained earnings of $20 million, as of January 1, 2007.

 

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets.” This statement requires that servicing assets or liabilities be initially measured at fair value, with subsequent changes in value reported based on either a fair value or amortized cost approach for each class of servicing assets or liabilities. Under previous guidance, such servicing assets or liabilities were initially measured at historical cost and the amortized cost method was required for subsequent reporting. The Company adopted this guidance effective January 1, 2007, and elected to continue reporting subsequent changes in value using the amortized cost approach. Adoption of this guidance had no material effect on the Company’s consolidated financial position or results of operations.

 

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments.” This statement eliminates an exception from the requirement to bifurcate an embedded derivative feature from beneficial interests in securitized financial assets. The Company has used this exception for investments the Company has made in securitized financial assets in the normal course of operations, and thus has not previously had to consider whether such investments contain an embedded derivative. The new requirement to identify embedded derivatives in beneficial interests will be applied on a prospective basis only to beneficial interests acquired, issued, or subject to certain remeasurement conditions after the adoption of the guidance. This statement also provides an election, on an instrument by instrument basis, to measure at fair value an entire hybrid financial instrument that contains an embedded derivative requiring bifurcation, rather than measuring only the embedded derivative on a fair value basis. If the fair value election is chosen, changes in unrealized gains and losses are reflected in the Consolidated Statements of Operations. The Company adopted this guidance effective January 1, 2007. The Company’s adoption of this guidance did not have a material effect on the Company’s consolidated financial position or results of operations.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not change which assets and liabilities are required to be recorded at fair value, but the application of this statement could change current practices in determining fair value. This statement is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. The Company plans to adopt this guidance effective January 1, 2008. The Company is currently assessing the impact of SFAS No. 157 on the Company’s consolidated financial position and results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This statement provides companies with an option to report selected financial assets and liabilities at fair value, with the associated changes in fair value reflected in the Consolidated Statements of Operations. This statement is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. The Company plans to adopt this guidance effective January 1, 2008. The Company is currently assessing the impact of SFAS No. 159 on its consolidated financial position and results of operations.

 

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” an amendment of FASB Statements No. 87, 88, 106 and 132(R). This statement requires an employer on a prospective basis to recognize the overfunded or underfunded status of its defined benefit pension and postretirement plans as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. The Company adopted this requirement, along with the required disclosures, on December 31, 2006. SFAS No. 158 also requires an employer on a prospective basis to measure the funded status of its plans as of its

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

fiscal year-end. This requirement is effective for fiscal years ending after December 15, 2008. The Company expects to adopt this guidance on December 31, 2008 and is currently assessing the impact that changing from a September 30 measurement date to a December 31 measurement date will have on the Company’s consolidated financial position and results of operations.

 

3. ACQUISITIONS AND DISPOSITIONS

 

Acquisition of The Allstate Corporation’s Variable Annuity Business

 

On June 1, 2006 (the “date of acquisition”), the Company acquired the variable annuity business of The Allstate Corporation (“Allstate”) through a reinsurance transaction for $635 million of total consideration, consisting primarily of a $628 million ceding commission. The reinsurance arrangements with Allstate include a coinsurance arrangement associated with the general account liabilities assumed and a modified coinsurance arrangement associated with the separate account liabilities assumed. The assets acquired and liabilities assumed have been included in the Company’s Consolidated Financial Statements as of the date of acquisition. The Company’s results of operations include the results of the acquired variable annuity business beginning from the date of acquisition. Pro forma information for this acquisition is omitted as the impact is not material.

 

Acquisition of CIGNA Corporation’s (“CIGNA”) Retirement Business

 

The Company acquired the retirement business of CIGNA for cash consideration of $2.1 billion on April 1, 2004 and the results of this business have been included in the Company’s consolidated results since the date of acquisition. As an element of the acquisition, the Company had the right, beginning two years after the acquisition, to commute the modified-coinsurance-with-assumption arrangement related to the acquired defined benefit guaranteed-cost contracts in exchange for cash consideration from CIGNA. Effective April 1, 2006, the Company reached an agreement with CIGNA to convert the modified-coinsurance-with-assumption arrangement to an indemnity coinsurance arrangement, effectively retaining the economics of the defined benefit guaranteed-cost contracts for the life of the block of business. Upon conversion, the Company extinguished its reinsurance receivable and payable with CIGNA related to the modified-coinsurance-with-assumption arrangement. Concurrently, the Company assumed $1.7 billion of liabilities from CIGNA under the indemnity coinsurance arrangement and received the related assets.

 

Discontinued Operations

 

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

 

     Three Months Ended
March 31,


 
     2007

    2006

 
     (in millions)  

Real estate investments sold or held for sale

   $ 18     $ —    

Canadian intermediate weekly premium and individual health operations

     —         (4 )

Healthcare operations

     5       —    

Other

     (3 )     (4 )
    


 


Income (loss) from discontinued operations before income taxes

     20       (8 )

Income tax expense (benefit)

     (18 )     (2 )
    


 


Income (loss) from discontinued operations, net of taxes

   $ 38     $ (6 )
    


 


 

The three months ended March 31, 2007 includes a $26 million tax benefit associated with a discontinued international business.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The Company’s Unaudited Interim Consolidated Statements of Financial Position include total assets and total liabilities related to discontinued businesses of $222 million and $105 million, respectively, as of March 31, 2007 and $306 million and $119 million, respectively, as of December 31, 2006. Charges recorded in connection with the disposals of businesses include estimates that are subject to subsequent adjustment. It is possible that such adjustments might be material to future net results of operations of a particular quarterly or annual period.

 

4. CLOSED BLOCK

 

On the date of demutualization, Prudential Insurance established a Closed Block for certain individual life insurance policies and annuities issued by Prudential Insurance in the U.S. The recorded assets and liabilities were allocated to the Closed Block at their historical carrying amounts. The Closed Block forms the principal component of the Closed Block Business.

 

The policies included in the Closed Block are specified individual life insurance policies and individual annuity contracts that were in force on the effective date of the Plan of Reorganization and for which Prudential Insurance is currently paying or expects to pay experience-based policy dividends. Assets have been allocated to the Closed Block in an amount that has been determined to produce cash flows which, together with revenues from policies included in the Closed Block, are expected to be sufficient to support obligations and liabilities relating to these policies, including provision for payment of benefits, certain expenses, and taxes and to provide for continuation of the policyholder dividend scales in effect in 2000, assuming experience underlying such scales continues. To the extent that, over time, cash flows from the assets allocated to the Closed Block and claims and other experience related to the Closed Block are, in the aggregate, more or less favorable than what was assumed when the Closed Block was established, total dividends paid to Closed Block policyholders in the future may be greater than or less than the total dividends that would have been paid to these policyholders if the policyholder dividend scales in effect in 2000 had been continued. Any cash flows in excess of amounts assumed will be available for distribution over time to Closed Block policyholders and will not be available to stockholders. If the Closed Block has insufficient funds to make guaranteed policy benefit payments, such payments will be made from assets outside of the Closed Block. The Closed Block will continue in effect as long as any policy in the Closed Block remains in force unless, with the consent of the New Jersey insurance regulator, it is terminated earlier.

 

The excess of Closed Block Liabilities over Closed Block Assets at the date of the demutualization (adjusted to eliminate the impact of related amounts in “Accumulated other comprehensive income (loss)”) represented the estimated maximum future earnings at that date from the Closed Block expected to result from operations attributed to the Closed Block after income taxes. In establishing the Closed Block, the Company developed an actuarial calculation of the timing of such maximum future earnings. If actual cumulative earnings of the Closed Block from inception through the end of any given period are greater than the expected cumulative earnings, only the expected earnings will be recognized in income. Any excess of actual cumulative earnings over expected cumulative earnings will represent undistributed accumulated earnings attributable to policyholders, which are recorded as a policyholder dividend obligation. The policyholder dividend obligation represents amounts to be paid to Closed Block policyholders as an additional policyholder dividend unless otherwise offset by future Closed Block performance that is less favorable than originally expected. If the actual cumulative earnings of the Closed Block from its inception through the end of any given period are less than the expected cumulative earnings of the Closed Block, the Company will recognize only the actual earnings in income. However, the Company may reduce policyholder dividend scales in the future, which would be intended to increase future actual earnings until the actual cumulative earnings equaled the expected cumulative earnings. The Company recognized a policyholder dividend obligation of $570 million and $483 million as of March 31, 2007 and December 31, 2006, respectively, to Closed Block policyholders for the excess of actual cumulative earnings over the expected cumulative earnings. Additionally, net unrealized investment gains that have arisen

 

10


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

subsequent to the establishment of the Closed Block were reflected as a policyholder dividend obligation of $1.747 billion and $1.865 billion as of March 31, 2007 and December 31, 2006, respectively, to be paid to Closed Block policyholders unless otherwise offset by future experience, with an offsetting amount reported in “Accumulated other comprehensive income (loss).” See the table below for changes in the components of the policyholder dividend obligation for the three months ended March 31, 2007.

 

Closed Block Liabilities and Assets designated to the Closed Block, as well as maximum future earnings to be recognized from Closed Block Liabilities and Closed Block Assets, are as follows:

 

     March 31,
2007


    December 31,
2006


 
     (in millions)  

Closed Block Liabilities

                

Future policy benefits

   $ 50,743     $ 50,705  

Policyholders’ dividends payable

     1,167       1,108  

Policyholder dividend obligation

     2,317       2,348  

Policyholders’ account balances

     5,558       5,562  

Other Closed Block liabilities

     9,123       10,800  
    


 


Total Closed Block Liabilities

     68,908       70,523  
    


 


Closed Block Assets

                

Fixed maturities, available for sale, at fair value

     45,689       46,707  

Equity securities, available for sale, at fair value

     3,772       3,684  

Commercial loans

     6,677       6,794  

Policy loans

     5,396       5,415  

Other long-term investments

     927       922  

Short-term investments

     1,598       1,765  
    


 


Total investments

     64,059       65,287  

Cash and cash equivalents

     822       1,275  

Accrued investment income

     673       662  

Other Closed Block assets

     327       277  
    


 


Total Closed Block Assets

     65,881       67,501  
    


 


Excess of reported Closed Block Liabilities over Closed Block Assets

     3,027       3,022  

Portion of above representing accumulated other comprehensive income:

                

Net unrealized investment gains

     1,711       1,844  

Allocated to policyholder dividend obligation

     (1,747 )     (1,865 )
    


 


Future earnings to be recognized from Closed Block Assets and Closed Block Liabilities

   $ 2,991     $ 3,001  
    


 


 

Information regarding the policyholder dividend obligation is as follows:

 

     Three Months Ended
March 31, 2007


 
     (in millions)  

Balance, January 1, 2007

   $ 2,348  

Impact on income before gains allocable to policyholder dividend obligation

     87  

Change in unrealized investment gains

     (118 )
    


Balance, March 31, 2007

   $ 2,317  
    


 

11


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Closed Block revenues and benefits and expenses for the three months ended March 31, 2007 and 2006 were as follows:

 

    

Three Months Ended

March 31,


     2007

   2006

     (in millions)

Revenues

             

Premiums

   $ 838    $ 846

Net investment income

     859      864

Realized investment gains (losses), net

     200      59

Other income

     13      13
    

  

Total Closed Block revenues

     1,910      1,782
    

  

Benefits and Expenses

             

Policyholders’ benefits

     949      932

Interest credited to policyholders’ account balances

     36      36

Dividends to policyholders

     683      603

General and administrative expenses

     171      183
    

  

Total Closed Block benefits and expenses

     1,839      1,754
    

  

Closed Block revenues, net of Closed Block benefits and expenses, before income taxes and discontinued operations

     71      28

Income tax expense

     63      15
    

  

Closed Block revenues, net of Closed Block benefits and expenses and income taxes, before discontinued operations

     8      13

Income from discontinued operations, net of taxes

     2      —  
    

  

Closed Block revenues, net of Closed Block benefits and expenses, income taxes and discontinued operations

   $ 10    $ 13
    

  

 

5. STOCKHOLDERS’ EQUITY

 

The Company has outstanding two classes of common stock: the Common Stock and the Class B Stock. The changes in the number of shares issued, held in treasury and outstanding are as follows for the periods indicated:

 

     Common Stock

    Class B
Stock


     Issued

   Held In
Treasury


    Outstanding

    Issued and
Outstanding


     (in millions)

Balance, December 31, 2006

   604.9    133.8     471.1     2.0

Common Stock issued

   —      —       —       —  

Common Stock acquired

   —      8.4     (8.4 )   —  

Stock-based compensation programs(1)

   —      (2.9 )   2.9     —  
    
  

 

 

Balance, March 31, 2007

   604.9    139.3     465.6     2.0
    
  

 

 

(1) Represents net shares issued from treasury pursuant to the Company’s stock-based compensation program.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Common Stock Held in Treasury

 

In November 2006, Prudential Financial’s Board of Directors authorized the Company to repurchase up to $3.0 billion of its outstanding Common Stock in calendar year 2007. The timing and amount of any repurchases under this authorization will be determined by management based upon market conditions and other considerations, and the repurchases may be effected in the open market, through derivative, accelerated repurchase and other negotiated transactions and through prearranged trading plans complying with Rule 10b5-1(c) of the Exchange Act. The 2007 stock repurchase program supersedes all previous repurchase programs. During the three months ended March 31, 2007, the Company acquired 8.4 million shares of its Common Stock at a total cost of $749 million.

 

Comprehensive Income

 

The components of comprehensive income are as follows:

 

     Three Months Ended
March 31,


 
     2007

     2006

 
     (in millions)  

Net income

   $ 1,120      $ 733  

Other comprehensive income (loss), net of taxes:

                 

Change in foreign currency translation adjustments

     (40 )      62  

Change in net unrealized investments gains (losses)(1)

     201        (700 )

Change in pension and postretirement unrecognized net periodic benefit (cost)

     12        —    

Additional minimum pension liability adjustment

     —          (1 )
    


  


Other comprehensive income(loss)(2)

     173        (639 )
    


  


Comprehensive income

   $ 1,293      $ 94  
    


  



(1) Includes cash flow hedges of $3 million and $(7) million for the three months ended March 31, 2007 and 2006, respectively.
(2) Amounts are net of taxes of $131 million and $(344) million for the three months ended March 31, 2007 and 2006, respectively.

 

The balance of and changes in each component of “Accumulated other comprehensive income” for the three months ended March 31, 2007 are as follows (net of taxes):

 

     Accumulated Other Comprehensive Income (Loss)

     Foreign
Currency
Translation
Adjustments


   

Net

Unrealized

Investment

Gains (Losses)(1)


   Pension and
Postretirement
Unrecognized
Net Periodic
Benefit (Cost)


    Total
Accumulated
Other
Comprehensive
Income (Loss)


     (in millions)

Balance, December 31, 2006

   $ 122     $ 1,171    $ (774 )   $ 519

Change in component during period

     (40 )     201      12       173
    


 

  


 

Balance, March 31, 2007

   $ 82     $ 1,372    $ (762 )   $ 692
    


 

  


 


(1) Includes cash flow hedges of $(121) million and $(124) million as of March 31, 2007 and December 31, 2006, respectively.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

6. EARNINGS PER SHARE

 

The Company has outstanding two separate classes of common stock. The Common Stock reflects the performance of the Financial Services Businesses and the Class B Stock reflects the performance of the Closed Block Business. Accordingly, earnings per share is calculated separately for each of these two classes of common stock.

 

Net income for the Financial Services Businesses and the Closed Block Business is determined in accordance with U.S. GAAP and includes general and administrative expenses charged to each of the respective businesses based on the Company’s methodology for the allocation of such expenses. Cash flows between the Financial Services Businesses and the Closed Block Business related to administrative expenses are determined by a policy servicing fee arrangement that is based upon insurance and policies in force and statutory cash premiums. To the extent reported administrative expenses vary from these cash flow amounts, the differences are recorded, on an after tax basis, as direct equity adjustments to the equity balances of the businesses.

 

The direct equity adjustments modify the earnings available to each of the classes of common stock for earnings per share purposes.

 

Common Stock

 

A reconciliation of the numerators and denominators of the basic and diluted per share computations is as follows:

 

     Three Months Ended March 31,

     2007

   2006

     Income

   Weighted
Average
Shares


   Per
Share
Amount


   Income

   Weighted
Average
Shares


   Per
Share
Amount


     (in millions, except per share amounts)

Basic earnings per share

                                     

Income from continuing operations attributable to the Financial Services Businesses

   $ 989                $ 681            

Direct equity adjustment

     15                  19            
    

              

           

Income from continuing operations attributable to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment

   $ 1,004    468.4    $ 2.14    $ 700    494.6    $ 1.42
    

  
  

  

  
  

Effect of dilutive securities and compensation programs

                                     

Stock options

          5.8                  6.5       

Deferred and long-term compensation programs

          3.0                  3.0       
           
                
      

Diluted earnings per share

                                     

Income from continuing operations attributable to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment

   $ 1,004    477.2    $ 2.10    $ 700    504.1    $ 1.39
    

  
  

  

  
  

 

The Company’s convertible senior notes provide for the Company to issue shares of its Common Stock as a component of the conversion of the notes. The notes will be dilutive to earnings per share if the average market price of the Common Stock for a particular period is above $90.00 for the $2 billion November 2005 issuance, which the Company has called for redemption in May 2007, or above $104.21 for the $2 billion December 2006 issuance.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

For the three months ended March 31, 2007 and 2006, 1.2 million and 1.5 million options, respectively, weighted for the portion of the period they were outstanding, with a weighted average exercise price of $91.03 and $75.99 per share, respectively, were excluded from the computation of diluted earnings per share because the options, based on application of the treasury stock method, were antidilutive.

 

Class B Stock

 

Income from continuing operations per share of Class B Stock was $39.00 and $19.50 for the three months ended March 31, 2007 and 2006, respectively.

 

The income from continuing operations attributable to the Closed Block Business available to holders of Class B Stock after direct equity adjustment for the three months ended March 31, 2007 and 2006 amounted to $78 million and $39 million, respectively. The direct equity adjustment resulted in a decrease in the income from continuing operations attributable to the Closed Block Business applicable to holders of Class B Stock for earnings per share purposes of $15 million and $19 million for the three months ended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007 and 2006, the weighted average number of shares of Class B Stock used in the calculation of earnings per share amounted to two million. There are no potentially dilutive shares associated with the Class B Stock.

 

7. EMPLOYEE BENEFIT PLANS

 

The Company has funded and non-funded contributory and non-contributory defined benefit pension plans, which cover substantially all of its employees. For some employees, benefits are based on final average earnings and length of service, while benefits for other employees are based on an account balance that takes into consideration age, service and earnings during their career.

 

The Company provides certain health care and life insurance benefits for its retired employees, their beneficiaries and covered dependents (“other postretirement benefits”). The health care plan is contributory; the life insurance plan is non-contributory. Substantially all of the Company’s U.S. employees may become eligible to receive other postretirement benefits if they retire after age 55 with at least 10 years of service or under certain circumstances after age 50 with at least 20 years of continuous service.

 

Net periodic (benefit) cost included in “General and administrative expenses” includes the following components:

 

     Three Months Ended March 31,

 
     Pension Benefits

    Other Postretirement
Benefits


 
     2007

    2006

    2007

    2006

 
     (in millions)  

Components of net periodic (benefit) cost

                                

Service cost

   $ 42     $ 40     $ 3     $ 3  

Interest cost

     108       104       34       32  

Expected return on plan assets

     (192 )     (185 )     (23 )     (22 )

Amortization of prior service cost

     7       6       (1 )     (2 )

Amortization of actuarial (gain) loss, net

     7       12       3       4  

Special termination benefits

     —         2       —         —    
    


 


 


 


Net periodic (benefit) cost

   $ (28 )   $ (21 )   $ 16     $ 15  
    


 


 


 


 

15


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

On April 30, 2007, the Company transferred $1 billion of assets from the qualified pension plan to the medical benefits component of the postretirement plan under Section 420 of the Internal Revenue Code. The transfer resulted in a reduction to the prepaid benefit for the qualified pension plan and an offsetting decrease in the accrued benefit liability for the postretirement plan with no net effect on stockholders’ equity on the Company’s consolidated financial position. The transfer had no impact on the Company’s consolidated results of operations, but will reduce the future cash contributions required to be made to the postretirement plan.

 

The Company made cash contributions during the three months ended March 31, 2007 of $35 million to its postretirement plans and anticipates that it will make cash contributions for the remainder of 2007 of approximately $20 million. The Company does not anticipate making any contributions to the qualified pension plan in 2007 and continues to anticipate contributing approximately $80 million in 2007 to the non-qualified pension plans.

 

8. SEGMENT INFORMATION

 

Segments

 

The Company has organized its principal operations into the Financial Services Businesses and the Closed Block Business. Within the Financial Services Businesses, the Company operates through three divisions, which together encompass eight reportable segments. The Company’s real estate and relocation services business as well as businesses that are not sufficiently material to warrant separate disclosure and businesses to be divested are included in Corporate and Other operations within the Financial Services Businesses. Collectively, the businesses that comprise the three operating divisions and Corporate and Other are referred to as the Financial Services Businesses.

 

Adjusted Operating Income

 

In managing the Financial Services Businesses, the Company analyzes the operating performance of each segment using “adjusted operating income.” Adjusted operating income does not equate to “income from continuing operations before income taxes and equity in earnings of operating joint ventures” or “net income” as determined in accordance with U.S. GAAP but is the measure of segment profit or loss used by the Company to evaluate segment performance and allocate resources, and, consistent with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” is the measure of segment performance presented below.

 

Adjusted operating income is calculated by adjusting each segment’s “income from continuing operations before income taxes and equity in earnings of operating joint ventures” for the following items, which are described in greater detail below:

 

   

realized investment gains (losses), net, and related charges and adjustments;

 

   

net investment gains and losses on trading account assets supporting insurance liabilities and changes in experience-rated contractholder liabilities due to asset value changes;

 

   

the contribution to income/loss of divested businesses that have been or will be sold or exited but that did not qualify for “discontinued operations” accounting treatment under U.S. GAAP; and

 

   

equity in earnings of operating joint ventures.

 

These items are important to an understanding of overall results of operations. Adjusted operating income is not a substitute for income determined in accordance with U.S. GAAP, and the Company’s definition of adjusted operating income may differ from that used by other companies. However, the Company believes that the

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

presentation of adjusted operating income as measured for management purposes enhances the understanding of results of operations by highlighting the results from ongoing operations and the underlying profitability factors of the Financial Services Businesses.

 

Realized investment gains (losses), net, and related charges and adjustments.    Adjusted operating income excludes realized investment gains (losses), net, except as indicated below. A significant element of realized investment gains and losses are impairments and credit-related and interest rate-related gains and losses. Impairments and losses from sales of credit-impaired securities, the timing of which depends largely on market credit cycles, can vary considerably across periods. The timing of other sales that would result in gains or losses, such as interest rate-related gains or losses, is largely subject to the Company’s discretion and influenced by market opportunities, as well as the Company’s tax profile. Trends in the underlying profitability of the Company’s businesses can be more clearly identified without the fluctuating effects of these transactions.

 

Charges that relate to realized investment gains (losses), net, are also excluded from adjusted operating income. The related charges relate to: policyholder dividends; amortization of deferred policy acquisition costs, valuation of business acquired (“VOBA”), unearned revenue reserves and deferred sales inducements; interest credited to policyholders’ account balances; reserves for future policy benefits; payments associated with the market value adjustment features related to certain of the annuity products we sell; and minority interest in consolidated operating subsidiaries. The related charges associated with policyholder dividends include a percentage of net realized investment gains on specified Gibraltar Life assets that is required to be paid as dividends to Gibraltar Life policyholders. Deferred policy acquisition costs, VOBA, unearned revenue reserves and deferred sales inducements for certain products are amortized based on estimated gross profits, which include net realized investment gains and losses on the underlying invested assets. The related charge for these items represent the portion of this amortization associated with net realized investment gains and losses. The related charges for interest credited to policyholders’ account balances relate to certain group life policies that pass back certain realized investment gains and losses to the policyholder. The reserves for certain policies are adjusted when cash flows related to these policies are affected by net realized investment gains and losses, and the related charge for reserves for future policy benefits represents that adjustment. Certain of our annuity products contain a market value adjustment feature that requires us to pay to the contractholder or entitles us to receive from the contractholder, upon surrender, a market value adjustment based on the crediting rates on the contract surrendered compared to crediting rates on newly issued contracts or based on an index rate at the time of purchase compared to an index rate at time of surrender, as applicable. These payments mitigate the net realized investment gains or losses incurred upon the disposition of the underlying invested assets. The related charge represents the payments or receipts associated with these market value adjustment features. Minority interest expense is recorded for the earnings of consolidated subsidiaries owed to minority investors. The related charge for minority interest in consolidated operating subsidiaries represents the portion of these earnings associated with net realized investment gains and losses.

 

Adjustments to “Realized investment gains (losses), net,” for purposes of calculating adjusted operating income, include the following:

 

Gains and losses pertaining to derivative contracts that do not qualify for hedge accounting treatment, other than derivatives used in the Company’s capacity as a broker or dealer, are included in “Realized investment gains (losses), net.” This includes mark-to-market adjustments of open contracts as well as periodic settlements. As discussed further below, adjusted operating income includes a portion of realized gains and losses pertaining to certain derivative contracts.

 

Adjusted operating income of the International Insurance segment and International Investments segment, excluding the global commodities group, reflect the impact of an intercompany arrangement with Corporate and

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Other operations pursuant to which the segments’ non-U.S. dollar denominated earnings in all countries for a particular year, including its interim reporting periods, are translated at fixed currency exchange rates. The fixed rates are determined in connection with a currency hedging program designed to mitigate the risk that unfavorable rate changes will reduce the segments’ U.S. dollar equivalent earnings. Pursuant to this program, the Company’s Corporate and Other operations execute forward currency contracts with third parties to sell the hedged currency in exchange for U.S. dollars at a specified exchange rate. The maturities of these contracts correspond with the future periods in which the identified non-U.S. dollar denominated earnings are expected to be generated. These contracts do not qualify for hedge accounting under U.S. GAAP and, as noted above, all resulting profits or losses from such contracts are included in “Realized investment gains (losses), net.” When the contracts are terminated in the same period that the expected earnings emerge, the resulting positive or negative cash flow effect is included in adjusted operating income (gains of $21 million and gains of $6 million for the three months ended March 31, 2007 and 2006, respectively). As of March 31, 2007 and December 31, 2006, the fair value of open contracts used for this purpose was a net asset of $98 million and a net asset of $105 million, respectively.

 

The Company uses interest and currency swaps and other derivatives to manage interest and currency exchange rate exposures arising from mismatches between assets and liabilities, including duration mismatches. For the derivative contracts that do not qualify for hedge accounting treatment, mark-to-market adjustments of open contracts as well as periodic settlements are included in “Realized investment gains (losses), net.” However, the periodic swap settlements, as well as other derivative related yield adjustments, are included in adjusted operating income to reflect the after-hedge yield of the underlying instruments. Adjusted operating income includes gains of $23 million and gains of $5 million for the three months ended March 31, 2007 and 2006, respectively, due to periodic settlements and yield adjustments of such contracts.

 

Certain products the Company sells are accounted for as freestanding derivatives or contain embedded derivatives. Changes in the fair value of these derivatives, along with any fees received or payments made relating to the derivative, are recorded in “Realized investment gains (losses), net.” These “Realized investment gains (losses), net” are included in adjusted operating income in the period in which the gain or loss is recorded. In addition, the changes in fair value of any associated derivative portfolio that is part of an economic hedging program related to the risk of these products (but which do not qualify for hedge accounting treatment under U.S. GAAP) are also included in adjusted operating income in the period in which the gains or losses on the derivative portfolio are recorded. Adjusted operating income includes gains of $15 million and gains of $3 million for the three months ended March 31, 2007 and 2006, respectively, related to these products and any associated derivative portfolio.

 

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 that are marked to market through “Realized investment gains (losses), net,” based upon the change in value of the underlying portfolio. Adjusted operating income includes a portion of the cumulative realized investment gains on these embedded derivatives on an amortizing basis over the remaining life of the securities. However, adjusted operating income includes any cumulative realized investment losses immediately. Adjusted operating income includes gains of $1 million and losses of $1 million for the three months ended March 31, 2007 and 2006, respectively, related to these embedded derivatives.

 

Adjustments are also made for the purposes of calculating adjusted operating income for the following items:

 

Within the Company’s Asset Management segment, its commercial mortgage operations originate loans for sale, including through securitization transactions. The “Realized investment gains (losses), net” associated with

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

these loans, including related derivative results and retained mortgage servicing rights, are a principal source of earnings for this business and are included in adjusted operating income. Also within the Company’s Asset Management segment, its proprietary investing business makes investments for sale or syndication to other investors or for placement or co-investment in the Company’s managed funds and structured products. The “Realized investment gains (losses), net” associated with the sale of these proprietary investments are a principal source of earnings for this business and are included in adjusted operating income. In addition, “Realized investment gains (losses), net” from derivatives used to hedge certain foreign currency-denominated proprietary investments are included in adjusted operating income. Net realized investment gains of $19 million and $43 million related to these businesses were included in adjusted operating income for the three months ended March 31, 2007 and 2006, respectively.

 

The Company’s Japanese insurance operations invest in “dual currency” fixed maturities and loans, which pay interest in U.S. dollars, while the principal is payable in Japanese yen. For fixed maturities that are categorized as held to maturity, and loans where the Company’s intent is to hold them to maturity, the change in value related to foreign currency fluctuations associated with the U.S. dollar interest payments is recorded in “Asset management fees and other income.” Since these investments will be held until maturity, the foreign exchange impact will ultimately be realized as net investment income as earned and therefore the impact of currency fluctuations is excluded from current period adjusted operating income. This change in value related to foreign currency fluctuations recorded within “Asset management fees and other income” is excluded from adjusted operating income and is reflected as an adjustment to “Realized investment gains (losses), net,” and was a net gain of $6 million and a net loss of $9 million for the three months ended March 31, 2007 and 2006, respectively.

 

In addition, the Company has certain other assets and liabilities for which, under GAAP, the change in value due to changes in foreign currency exchange rates is recorded in “Asset management fees and other income.” To the extent the foreign currency exposure on these assets and liabilities is economically hedged, the change in value included in “Asset management fees and other income” is excluded from adjusted operating income and is reflected as an adjustment to “Realized investment gains (losses), net,” and was a net gain of $6 million for the there months ended March 31, 2007. There was zero net change in value for the three months ended March 31, 2006.

 

Investment gains and losses on trading account assets supporting insurance liabilities and changes in experience-rated contractholder liabilities due to asset value changes. Certain products included in the retirement business acquired from CIGNA, as well as certain products included in the International Insurance segment, are experience-rated in that investment results associated with these products will ultimately accrue to contractholders. The investments supporting these experience-rated products, excluding mortgage loans, are classified as trading. These trading investments are reflected on the statements of financial position as “Trading account assets supporting insurance liabilities, at fair value.” Realized and unrealized gains and losses for these investments are reported in “Asset management fees and other income.” Investment income for these investments is reported in “Net investment income.” Mortgage loans that support these experience-rated products are carried at unpaid principal, net of unamortized discounts and an allowance for losses, and are reflected on the statements of financial position as “Commercial loans.”

 

Adjusted operating income excludes net investment gains and losses on trading account assets supporting insurance liabilities. This is consistent with the exclusion of realized investment gains and losses with respect to other investments supporting insurance liabilities managed on a consistent basis, as discussed above. In addition, to be consistent with the historical treatment of charges related to realized investment gains and losses on available for sale securities, adjusted operating income also excludes the change in contractholder liabilities due to asset value changes in the pool of investments (including mortgage loans) supporting these experience-rated contracts, which are reflected in “Interest credited to policyholders’ account balances.” The result of this

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

approach is that adjusted operating income for these products includes only net fee revenue and interest spread the Company earns on these experience-rated contracts, and excludes changes in fair value of the pool of investments, both realized and unrealized, that accrue to the contractholders.

 

Divested businesses. The contribution to income/loss of divested businesses that have been or will be sold or exited, but that did not qualify for “discontinued operations” accounting treatment under U.S. GAAP, are excluded from adjusted operating income as the results of divested businesses are not relevant to understanding the Company’s ongoing operating results.

 

Equity in earnings of operating joint ventures. Equity in earnings of operating joint ventures, on a pre-tax basis, are included in adjusted operating income as these results are a principal source of earnings. These earnings are reflected on a GAAP basis on an after-tax basis as a separate line on the Company’s Consolidated Statements of Operations.

 

The summary below reconciles adjusted operating income before income taxes for the Financial Services Businesses to income from continuing operations before income taxes and equity in earnings of operating joint ventures:

 

     Three Months Ended
March 31,


 
         2007    

        2006    

 
     (in millions)  

Adjusted Operating Income before income taxes for Financial Services Businesses by Segment:

                

Individual Life

   $ 101     $ 133  

Individual Annuities

     166       118  

Group Insurance

     51       47  
    


 


Total Insurance Division

     318       298  
    


 


Asset Management

     184       169  

Financial Advisory

     96       (66 )

Retirement

     148       137  
    


 


Total Investment Division

     428       240  
    


 


International Insurance

     413       338  

International Investments

     62       44  
    


 


Total International Insurance and Investments Division

     475       382  
    


 


Corporate Operations

     15       16  

Real Estate and Relocation Services

     (3 )     10  
    


 


Total Corporate and Other

     12       26  
    


 


Adjusted Operating Income before income taxes for Financial Services Businesses

     1,233       946  

Realized investment gains (losses), net, and related adjustments

     146       50  

Charges related to realized investment gains (losses), net

     (6 )     —    

Investment gains (losses) on trading account assets supporting insurance liabilities, net

     82       (114 )

Change in experience-rated contractholder liabilities due to asset value changes

     (62 )     66  

Divested businesses

     19       13  

Equity in earnings of operating joint ventures

     (120 )     (78 )
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures for Financial Services Businesses

     1,292       883  
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures for Closed Block Business

     137       84  
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 1,429     $ 967  
    


 


 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The Insurance division results reflect deferred policy acquisition costs as if the individual annuity business and group insurance business were stand-alone operations. The elimination of intersegment costs capitalized in accordance with this policy is included in consolidating adjustments within Corporate and Other operations.

 

The summary below presents revenues for the Company’s reportable segments:

 

     Three Months Ended
March 31,


 
         2007    

        2006    

 
     (in millions)  

Financial Services Businesses:

                

Individual Life

   $ 631     $ 559  

Individual Annuities

     604       453  

Group Insurance

     1,205       1,109  
    


 


Total Insurance Division

     2,440       2,121  
    


 


Asset Management

     557       502  

Financial Advisory

     157       178  

Retirement

     1,163       1,054  
    


 


Total Investment Division

     1,877       1,734  
    


 


International Insurance

     2,054       1,949  

International Investments

     177       150  
    


 


Total International Insurance and Investments Division

     2,231       2,099  
    


 


Corporate Operations

     100       110  

Real Estate and Relocation Services

     59       68  
    


 


Total Corporate and Other

     159       178  
    


 


Total

     6,707       6,132  
    


 


Realized investment gains (losses), net, and related adjustments

     146       50  

Charges related to realized investment gains (losses), net

     1       2  

Investment gains (losses) on trading account assets supporting insurance liabilities, net

     82       (114 )

Divested businesses

     14       7  

Equity in earnings of operating joint ventures

     (120 )     (78 )
    


 


Total Financial Services Businesses

     6,830       5,999  
    


 


Closed Block Business

     1,991       1,851  
    


 


Total per Unaudited Interim Consolidated Financial Statements

   $ 8,821     $ 7,850  
    


 


 

The Asset Management segment revenues include intersegment revenues of $84 million and $91 million for the three months ended March 31, 2007 and 2006, respectively, primarily consisting of asset-based management and administration fees. Management has determined the intersegment revenues with reference to market rates. Intersegment revenues are eliminated in consolidation in Corporate and Other.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The summary below presents total assets for the Company’s reportable segments as of the periods indicated:

 

     March 31,
2007


   December 31,
2006


     (in millions)

Individual Life

   $ 33,297    $ 33,041

Individual Annuities

     70,329      69,153

Group Insurance

     29,614      29,342
    

  

Total Insurance Division

     133,240      131,536
    

  

Asset Management

     41,266      38,524

Financial Advisory

     1,559      1,520

Retirement

     126,744      125,604
    

  

Total Investment Division

     169,569      165,648
    

  

International Insurance

     59,492      59,211

International Investments

     6,845      6,191
    

  

Total International Insurance and Investments Division

     66,337      65,402
    

  

Corporate Operations

     16,008      16,301

Real Estate and Relocation Services

     1,215      1,380
    

  

Total Corporate and Other

     17,223      17,681
    

  

Total Financial Services Businesses

     386,369      380,267
    

  

Closed Block Business

     72,539      73,999
    

  

Total per Unaudited Interim Consolidated Financial Statements

   $ 458,908    $ 454,266
    

  

 

9. CONTINGENT LIABILITIES AND LITIGATION AND REGULATORY MATTERS

 

Contingent Liabilities

 

On an ongoing basis, the Company’s internal supervisory and control functions review the quality of sales, marketing 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 product 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, the Company may offer customers remediation and may incur charges, including the cost of such remediation, administrative costs and regulatory fines.

 

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 as a result of payments in connection with the matters discussed above or other matters depending, in part, upon the results of operations or cash flow for such period. Management believes, however, that ultimate payments in connection with these matters, after consideration of applicable reserves and rights to indemnification, should not have a material adverse effect on the Company’s financial position.

 

Litigation and Regulatory Matters

 

The Company is subject to legal and regulatory actions in the ordinary course of its businesses. Pending legal and regulatory actions include proceedings relating to aspects of businesses and operations that are specific to the Company and proceedings that are typical of the businesses in which the Company operates, including in

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

both cases businesses that have either been divested or placed in wind-down status. 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.

 

Insurance and Annuities

 

In August 2000, plaintiffs filed a purported national class action in the District Court of Valencia County, New Mexico, Azar, et al. v. Prudential Insurance, based upon the alleged failure to adequately disclose the increased costs associated with payment of life insurance premiums on a “modal” basis, i.e., more frequently than once a year. Similar actions have been filed in New Mexico against over a dozen other insurance companies. The complaint asserts claims for breach of the common law duty to disclose material information, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, unjust enrichment and fraudulent concealment and seeks injunctive relief, compensatory and punitive damages, both in unspecified amounts, restitution, treble damages, interest, costs and attorneys’ fees. In March 2001, the court entered an order granting partial summary judgment to plaintiffs as to liability. In January 2003, the New Mexico Court of Appeals reversed this finding and dismissed the claims for breach of the covenant of good faith and fair dealing and breach of fiduciary duty. The case was remanded to the trial court and in November 2004, it held that, as to the named plaintiffs, the non-disclosure was material. In July 2005, the court certified a class of New Mexico only policyholders denying plaintiffs’ motion to include purchasers from 35 additional states. In September 2005, plaintiffs sought to amend the court’s order on class certification with respect to eight additional states. In March 2006, the court reiterated its denial of a multi-state class and maintained the certification of a class of New Mexico resident purchasers of Prudential life insurance. The court also indicated it would enter judgment on liability against Prudential for the New Mexico class.

 

From November 2002 to March 2005, eleven separate complaints were filed against the Company and the law firm of Leeds Morelli & Brown in New Jersey state court. The cases were consolidated for pre-trial proceedings in New Jersey Superior Court, Essex County and captioned Lederman v. Prudential Financial, Inc., et al. The complaints allege that an alternative dispute resolution agreement entered into among Prudential Insurance, over 350 claimants who are current and former Prudential Insurance employees, and Leeds Morelli & Brown (the law firm representing the claimants) was illegal and that Prudential Insurance conspired with Leeds Morelli & Brown to commit fraud, malpractice, breach of contract, and violate federal racketeering laws by advancing legal fees to the law firm with the purpose of limiting Prudential’s liability to the claimants. In 2004, the Superior Court sealed these lawsuits and compelled them to arbitration. In May 2006, the Appellate Division reversed the trial court’s decisions, held that the cases were improperly sealed, and should be heard in court rather than arbitrated. In November 2006, plaintiffs filed a motion seeking to permit over 200 individuals to join the cases as additional plaintiffs, to authorize a joint trial on liability issues for all plaintiffs, and to add a claim under the New Jersey discrimination law. In March 2007, the court granted plaintiffs’ motion to amend the complaint to add over 200 additional plaintiffs and a claim under the New Jersey discrimination law but denied without prejudice plaintiffs’ motion for a joint trial on liability issues. In April 2007, the amended complaint was filed.

 

The Company, along with a number of other insurance companies, received formal requests for information from the State of New York Attorney General’s Office (“NYAG”), the Securities and Exchange Commission (“SEC”), the Connecticut Attorney General’s Office, the Massachusetts Office of the Attorney General, the Department of Labor, the United States Attorney for the Southern District of California, the District Attorney of the County of San Diego, and various state insurance departments relating to payments to insurance intermediaries and certain other practices that may be viewed as anti-competitive. The Company may receive additional requests from these and other regulators and governmental authorities concerning these and related

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

subjects. The Company is cooperating with these inquiries and has had discussions with certain authorities in an effort to resolve the inquiries into this matter. In December 2006, Prudential Insurance reached a resolution of the NYAG investigation. Under the terms of the settlement, Prudential Insurance paid a $2.5 million penalty and established a $16.5 million fund for policyholders, adopted business reforms and agreed, among other things, to continue to cooperate with the NYAG in any litigation, ongoing investigations or other proceedings. Prudential Insurance also settled the litigation brought by the California Department of Insurance and agreed to business reforms and disclosures as to group insurance contracts insuring customers or residents in California and to pay certain costs of investigation. These matters are also the subject of litigation brought by private plaintiffs, including purported class actions that have been consolidated in the multidistrict litigation in the United States District Court for the District of New Jersey, In re Employee Benefit Insurance Brokerage Antitrust Litigation, and two shareholder derivative actions, Gillespie v. Ryan and Kahn v. Agnew. Both derivative actions were dismissed without prejudice. In Gillespie, the plaintiff entered into a tolling agreement with the Company to permit a Special Evaluation Committee of the Board of Directors to investigate and evaluate his demand that the Company take action regarding these matters. The Committee has completed its investigation and has informed counsel for Mr. Gillespie that it has determined to refuse his demand. The regulatory settlement may adversely affect the existing litigation or cause additional litigation and result in adverse publicity and other potentially adverse impacts to the Company’s business.

 

In April 2005, the Company voluntarily commenced a review of the accounting for its reinsurance arrangements to confirm that it complied with applicable accounting rules. This review included an inventory and examination of current and past arrangements, including those relating to the Company’s wind down and divested businesses and discontinued operations. Subsequent to commencing this voluntary review, the Company received a formal request from the Connecticut Attorney General for information regarding its participation in reinsurance transactions generally and a formal request from the SEC for information regarding certain reinsurance contracts entered into with a single counterparty since 1997 as well as specific contracts entered into with that counterparty in the years 1997 through 2002 relating to the Company’s property and casualty insurance operations that were sold in 2003. These investigations are ongoing and not yet complete and it is possible that the Company may receive additional requests from regulators relating to reinsurance arrangements. The Company intends to cooperate with all such requests.

 

The Company’s subsidiary, American Skandia Life Assurance Corporation, has commenced a remediation program to correct errors in the administration of approximately 11,000 annuity contracts issued by that company. The owners of these contracts did not receive notification that the contracts were approaching or past their designated annuitization date or default annuitization date (both dates referred to as the “contractual annuity date”) and the contracts were not annuitized at their contractual annuity dates. Some of these contracts also were affected by data integrity errors resulting in incorrect contractual annuity dates. The lack of notice and data integrity errors, as reflected on the annuities administrative system, all occurred before the acquisition of the American Skandia entities by the Company. The remediation and administrative costs of the remediation program are subject to the indemnification provisions of the acquisition agreement pursuant to which the Company purchased the American Skandia entities in May 2003 from Skandia.

 

Securities

 

Prudential Securities has been named as a defendant in a number of industry-wide purported class actions in the United States District Court for the Southern District of New York relating to its former securities underwriting business. Plaintiffs in one consolidated proceeding, captioned In re: Initial Public Offering Securities Litigation, allege, among other things, that the underwriters engaged in a scheme involving tying agreements, undisclosed compensation arrangements and research analyst conflicts to manipulate and inflate the

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

prices of shares sold in initial public offerings in violation of the federal securities laws. Certain issuers of these securities and their current and former officers and directors have also been named as defendants. In October 2004, the district court granted plaintiffs’ motion for class certification in six “focus cases.” In December 2006, the United States Court of Appeals for the Second Circuit vacated that decision. Plaintiffs have petitioned the Court of Appeals for rehearing and rehearing en banc. In June 2004, plaintiffs entered into a settlement agreement with the issuers, officers and directors named as defendants in the lawsuits, which the district court preliminarily approved in February 2005. In August 2000, Prudential Securities was named as a defendant, along with other underwriters, in a purported class action, captioned CHS Electronics Inc. v. Credit Suisse First Boston Corp. et al., which alleges on behalf of issuers of securities in initial public offerings that the defendants conspired to fix at 7% the discount that underwriting syndicates receive from issuers in violation of federal antitrust laws. Plaintiffs moved for class certification in September 2004 and for partial summary judgment in November 2005. The summary judgment motion has been deferred pending disposition of the class certification motion. In April 2006, the court denied class certification. In August 2006, the United States Court of Appeals for the Second Circuit granted plaintiffs’ petition for review of that decision. In a related action, captioned Gillet v. Goldman Sachs et al., plaintiffs allege substantially the same antitrust claims on behalf of investors, though only injunctive relief is currently being sought.

 

Other Matters

 

Mutual Fund Market Timing Practices

 

In August 2006, Prudential Equity Group, LLC (“PEG”), a wholly owned subsidiary of the Company, reached a resolution of the previously disclosed regulatory and criminal investigations into deceptive market related activities involving PEG’s former Prudential Securities operations. The settlements relate to conduct that generally occurred between 1999 and 2003 involving certain former Prudential Securities brokers in Boston and certain other branch offices in the U.S., their supervisors, and other members of the Prudential Securities control structure with responsibilities that related to the market timing activities, including certain former members of Prudential Securities senior management. The Prudential Securities operations were contributed to a joint venture with Wachovia Corporation in July 2003, but PEG retained liability for the market timing related activities. In connection with the resolution of the investigations, PEG entered into separate settlements with each of the United States Attorney for the District of Massachusetts (“USAO”), the Secretary of the Commonwealth of Massachusetts, Securities Division, the SEC, the National Association of Securities Dealers, the New York Stock Exchange, the New Jersey Bureau of Securities and the NYAG. These settlements resolve the investigations by the above named authorities into these matters as to all Prudential entities without further regulatory proceedings or filing of charges so long as the terms of the settlement are followed and provided, in the case of the settlement agreement reached with the USAO, that the USAO has reserved the right to prosecute PEG if there is a material breach by PEG of that agreement during its five year term and in certain other specified events. Under the terms of the settlements, PEG paid $270 million into a Fair Fund administered by the SEC to compensate those harmed by the market timing activities. In addition, $330 million was paid in fines and penalties. Pursuant to the settlements, PEG retained, at PEG’s ongoing cost and expense, the services of an Independent Distribution Consultant acceptable to certain of the authorities to develop a proposed distribution plan for the distribution of Fair Fund amounts according to a methodology developed in consultation with and acceptable to certain of the authorities. In addition, as part of the settlements, PEG has agreed, among other things, to continue to cooperate with the above named authorities in any litigation, ongoing investigations or other proceedings relating to or arising from their investigations into these matters. In connection with the settlements, the Company has agreed with the USAO, among other things, to cooperate with the USAO and to maintain and periodically report on the effectiveness of its compliance procedures. The settlement documents include findings and admissions that may adversely affect existing litigation or cause additional litigation and result in adverse publicity and other potentially adverse impacts to the Company’s businesses.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

In addition to the regulatory proceedings described above that were settled in 2006, in October 2004, the Company and Prudential Securities were named as defendants in several class actions brought on behalf of purchasers and holders of shares in a number of mutual fund complexes. The actions are consolidated as part of a multi-district proceeding, In re: Mutual Fund Investment Litigation, pending in the United States District Court for the District of Maryland. The complaints allege that the purchasers and holders were harmed by dilution of the funds’ values and excessive fees, caused by market timing and late trading, and seek unspecified damages. In August 2005, the Company was dismissed from several of the actions, without prejudice to repleading the state claims, but remains a defendant in other actions in the consolidated proceeding. In July 2006, in one of the consolidated mutual fund actions, Saunders v. Putnam American Government Income Fund, et al., the United States District Court for the District of Maryland granted plaintiffs leave to refile their federal securities law claims against Prudential Securities. In August 2006, the second amended complaint was filed alleging federal securities law claims on behalf of a purported nationwide class of mutual fund investors seeking compensatory and punitive damages in unspecified amounts. Motions to dismiss the other actions are pending.

 

Commencing in 2003, the Company received formal requests for information from the SEC and NYAG relating to market timing in variable annuities by certain American Skandia entities. In connection with these investigations, with the approval of Skandia Insurance Company Ltd. (publ) (“Skandia”), an offer was made by American Skandia to the authorities investigating its companies, the SEC and NYAG, to settle these matters by paying restitution and a civil penalty of $95 million in the aggregate. While not assured, the Company believes these discussions are likely to lead to settlements with these authorities. Any regulatory settlement involving an American Skandia entity would be subject to the indemnification provisions of the acquisition agreement pursuant to which the Company purchased the American Skandia entities in May 2003 from Skandia. If achieved, settlement of the matters relating to American Skandia also could involve continuing monitoring, changes to and/or supervision of business practices, findings that may adversely affect existing or cause additional litigation, adverse publicity and other adverse impacts to the Company’s businesses.

 

Other

 

In November 2003, an action was commenced in the United States Bankruptcy Court for the Southern District of New York, Enron Corp. v. J.P. Morgan Securities, Inc., et al., against approximately 100 defendants, including Prudential Insurance and related entities, which invested in Enron’s commercial paper. The complaint alleges that Enron’s October 2001 prepayment of its commercial paper is a voidable preference under the bankruptcy laws and constitutes a fraudulent conveyance and that the Company and related entities received prepayment of $125 million. A motion by all defendants to dismiss the complaint was denied in June 2005. Defendants’ motions for leave to appeal are pending. In April 2007, the Prudential defendants and Enron agreed to a tentative settlement of the adversary proceeding. The settlement terms are yet to be documented and the final agreement will be subject to court approval before the matter is concluded.

 

In August 1999, a Prudential Insurance employee and several Prudential Insurance retirees filed an action in the United States District Court for the Southern District of Florida, Dupree, et al., v. Prudential Insurance, et al., against Prudential Insurance and its Board of Directors in connection with a group annuity contract entered into in 1989 between the Prudential Retirement Plan and Prudential Insurance. The suit alleged that the annuitization of certain retirement benefits violated ERISA and that, in the event of demutualization, Prudential Insurance would retain shares distributed under the annuity contract in violation of ERISA’s fiduciary duty requirements. In July 2001, plaintiffs filed an amended complaint dropping three counts, and the Company filed an answer denying the essential allegations of the complaint. The amended complaint seeks injunctive and monetary relief, including the return of what are claimed to be excess investment and advisory fees paid by the Retirement Plan to Prudential. In March 2002, the court dismissed certain of the claims against the individual defendants. A non-jury trial was concluded in January 2005. The court has not yet issued its decision.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

In September and October 2005, five purported class action lawsuits were filed against the Company, PSI and PEG claiming that stockbrokers were improperly classified as exempt employees under state and federal wage and hour laws, were improperly denied overtime pay and that improper deductions were made from the stockbrokers’ wages. Two of the stockbrokers’ complaints, Janowsky v. Wachovia Securities, LLC and Prudential Securities Incorporated and Goldstein v. Prudential Financial, Inc., were filed in the United States District Court for the Southern District of New York. The Goldstein complaint purports to have been filed on behalf of a nationwide class. The Janowsky complaint alleges a class of New York brokers. Motions to dismiss and compel arbitration were filed in the Janowsky and Goldstein matters, which have been consolidated for pre-trial purposes. The three stockbrokers complaints filed in California Superior Court, Dewane v. Prudential Equity Group, Prudential Securities Incorporated, and Wachovia Securities LLC; DiLustro v. Prudential Securities Incorporated, Prudential Equity Group Inc. and Wachovia Securities; and Carayanis v. Prudential Equity Group LLC and Prudential Securities Inc., purport to have been brought on behalf of classes of California brokers. The Carayanis complaint was subsequently withdrawn without prejudice in May 2006. In June 2006, a purported New York state class action complaint was filed in the United States District Court for the Eastern District of New York, Panesenko v. Wachovia Securities, et al., alleging that the Company failed to pay overtime to stockbrokers in violation of state and federal law and that improper deductions were made from the stockbrokers’ wages in violation of state law. In September 2006, Prudential Securities was sued in Badain v. Wachovia Securities, et al., a purported nationwide class action filed in the United States District Court for the Western District of New York. The complaint alleges that Prudential Securities failed to pay overtime to stockbrokers in violation of state and federal law and that improper deductions were made from the stockbrokers’ wages in violation of state law. In October 2006, a purported class action lawsuit, Bouder v. Prudential Financial, Inc. and Prudential Insurance Company of America, was filed in the United States District Court for the District of New Jersey, claiming that the Company failed to pay overtime to insurance agents who were registered representatives in violation of federal and state law, and that improper deductions were made from these agents’ wages in violation of state law. In December 2006, the stockbrokers’ cases were transferred to the United States District Court for the Central District of California by the Judicial Panel on Multidistrict Litigation for coordinated or consolidated pre-trial proceedings. The complaints seek back overtime pay and statutory damages, recovery of improper deductions, interest, and attorneys’ fees.

 

In November 1996, plaintiffs filed a purported class action lawsuit against Prudential Insurance, the Prudential Home Mortgage Company, Inc. and several other subsidiaries in the Superior Court of New Jersey, Essex County, Capitol Life Insurance Company v. Prudential Insurance, et al., in connection with the sale of certain subordinated mortgage securities sold by a subsidiary of Prudential Home Mortgage. In May 2000, plaintiffs filed a second amended complaint that alleges violations of the New Jersey securities and RICO statutes, fraud, conspiracy and negligent misrepresentation, and seeks compensatory as well as treble and punitive damages. In 2002, class certification was denied. In August 2005, the court dismissed the New Jersey Securities Act and RICO claims and the negligent misrepresentation claim. In February 2007, the matter settled in principle. In April 2007, the matter settled for $7.5 million.

 

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. Management believes, however, that the ultimate outcome of all pending litigation and regulatory matters, after consideration of applicable reserves and rights to indemnification, should not have a material adverse effect on the Company’s financial position.

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Supplemental Combining Statements of Financial Position

March 31, 2007 and December 31, 2006 (in millions)

 

    March 31, 2007

  December 31, 2006

    Financial
Services
Businesses


  Closed
Block
Business


  Consolidated

  Financial
Services
Businesses


  Closed
Block
Business


  Consolidated

ASSETS

                                   

Fixed maturities:

                                   

Available for sale, at fair value

  $ 113,833   $ 49,772   $ 163,605   $ 112,043   $ 50,773   $ 162,816

Held to maturity, at amortized cost

    3,440     —       3,440     3,469     —       3,469

Trading account assets supporting insurance liabilities, at fair value

    14,223     —       14,223     14,262     —       14,262

Other trading account assets, at fair value

    2,119     —       2,119     2,209     —       2,209

Equity securities, available for sale, at fair value

    4,592     3,862     8,454     4,331     3,772     8,103

Commercial loans

    18,947     7,190     26,137     18,421     7,318     25,739

Policy loans

    3,575     5,396     8,971     3,472     5,415     8,887

Securities purchased under agreements to resell

    113     —       113     153     —       153

Other long-term investments

    4,339     895     5,234     3,780     965     4,745

Short-term investments

    3,291     1,673     4,964     3,183     1,851     5,034
   

 

 

 

 

 

Total investments

    168,472     68,788     237,260     165,323     70,094     235,417

Cash and cash equivalents

    5,950     858     6,808     7,243     1,346     8,589

Accrued investment income

    1,468     728     2,196     1,429     713     2,142

Reinsurance recoverables

    2,021     —       2,021     1,958     —       1,958

Deferred policy acquisition costs

    10,067     992     11,059     9,854     1,009     10,863

Other assets

    16,773     1,173     17,946     16,997     837     17,834

Separate account assets

    181,618     —       181,618     177,463     —       177,463
   

 

 

 

 

 

TOTAL ASSETS

  $ 386,369   $ 72,539   $ 458,908   $ 380,267   $ 73,999   $ 454,266
   

 

 

 

 

 

LIABILITIES AND ATTRIBUTED EQUITY

                                   

LIABILITIES

                                   

Future policy benefits

  $ 56,490   $ 50,744   $ 107,234   $ 56,245   $ 50,706   $ 106,951

Policyholders’ account balances

    75,132     5,558     80,690     75,090     5,562     80,652

Policyholders’ dividends

    548     3,484     4,032     526     3,456     3,982

Reinsurance payables

    1,472     —       1,472     1,458     —       1,458

Securities sold under agreements to repurchase

    4,794     5,004     9,798     5,747     5,734     11,481

Cash collateral for loaned securities

    3,697     2,537     6,234     4,082     3,283     7,365

Income taxes

    3,199     13     3,212     2,920     188     3,108

Securities sold but not yet purchased

    307     —       307     277     —       277

Short-term debt

    12,812     1,122     13,934     10,798     1,738     12,536

Long-term debt

    10,080     1,750     11,830     9,673     1,750     11,423

Other liabilities

    13,955     1,056     15,011     14,298     380     14,678

Separate account liabilities

    181,618     —       181,618     177,463     —       177,463
   

 

 

 

 

 

Total liabilities

    364,104     71,268     435,372     358,577     72,797     431,374
   

 

 

 

 

 

COMMITMENTS AND CONTINGENT LIABILITIES

                                   

ATTRIBUTED EQUITY

                                   

Accumulated other comprehensive income

    680     12     692     496     23     519

Other attributed equity

    21,585     1,259     22,844     21,194     1,179     22,373
   

 

 

 

 

 

Total attributed equity

    22,265     1,271     23,536     21,690     1,202     22,892
   

 

 

 

 

 

TOTAL LIABILITIES AND ATTRIBUTED EQUITY

  $ 386,369   $ 72,539   $ 458,908   $ 380,267   $ 73,999   $ 454,266
   

 

 

 

 

 

 

See Notes to Unaudited Interim Supplemental Combining Financial Information

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Supplemental Combining Statements of Operations

For the three months ended March 31, 2007 and 2006 (in millions)

 

     Three Months Ended March 31,

 
     2007

   2006

 
     Financial
Services
Businesses


   Closed
Block
Business


   Consolidated

   Financial
Services
Businesses


    Closed
Block
Business


   Consolidated

 

REVENUES

                                            

Premiums

   $ 2,721    $ 838    $ 3,559    $ 2,606     $ 846    $ 3,452  

Policy charges and fee income

     785      —        785      664       —        664  

Net investment income

     2,058      933      2,991      1,815       932      2,747  

Realized investment gains, net

     213      207      420      115       60      175  

Asset management fees and other income

     1,053      13      1,066      799       13      812  
    

  

  

  


 

  


Total revenues

     6,830      1,991      8,821      5,999       1,851      7,850  
    

  

  

  


 

  


BENEFITS AND EXPENSES

                                            

Policyholders’ benefits

     2,736      949      3,685      2,547       932      3,479  

Interest credited to policyholders’ account balances

     807      36      843      587       36      623  

Dividends to policyholders

     28      683      711      20       603      623  

General and administrative expenses

     1,967      186      2,153      1,962       196      2,158  
    

  

  

  


 

  


Total benefits and expenses

     5,538      1,854      7,392      5,116       1,767      6,883  
    

  

  

  


 

  


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

     1,292      137      1,429      883       84      967  
    

  

  

  


 

  


Income tax expense

     380      44      424      253       26      279  
    

  

  

  


 

  


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

     912      93      1,005      630       58      688  

Equity in earnings of operating joint ventures, net of taxes

     77      —        77      51       —        51  
    

  

  

  


 

  


INCOME FROM CONTINUING OPERATIONS

     989      93      1,082      681       58      739  

Income (loss) from discontinued operations, net of taxes

     36      2      38      (6 )     —        (6 )
    

  

  

  


 

  


NET INCOME

   $ 1,025    $ 95    $ 1,120    $ 675     $ 58    $ 733  
    

  

  

  


 

  


 

See Notes to Unaudited Interim Supplemental Combining Financial Information

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Supplemental Combining Financial Information

 

1. BASIS OF PRESENTATION

 

The supplemental combining financial information presents the consolidated financial position and results of operations for Prudential Financial, Inc. and its subsidiaries (together, the “Company”), separately reporting the Financial Services Businesses and the Closed Block Business. The Financial Services Businesses and the Closed Block Business are both fully integrated operations of the Company and are not separate legal entities. The supplemental combining financial information presents the results of the Financial Services Businesses and the Closed Block Business as if they were separate reporting entities and should be read in conjunction with the Consolidated Financial Statements.

 

The Company has outstanding two classes of common stock. The Common Stock reflects the performance of the Financial Services Businesses and the Class B Stock reflects the performance of the Closed Block Business.

 

The Closed Block Business was established on the date of demutualization and includes the assets and liabilities of the Closed Block (see Note 4 to the Unaudited Interim Consolidated Financial Statements for a description of the Closed Block). It also includes assets held outside the Closed Block necessary to meet insurance regulatory capital requirements related to products included within the Closed Block; deferred policy acquisition costs related to the Closed Block policies; the principal amount of the IHC debt (as discussed in Note 2 below) and related unamortized debt issuance costs, as well as an interest rate swap related to the IHC debt; and certain other related assets and liabilities. The Financial Services Businesses consist of the Insurance, Investment, and International Insurance and Investments divisions and Corporate and Other operations.

 

2. ALLOCATION OF RESULTS

 

This supplemental combining financial information reflects the assets, liabilities, revenues and expenses directly attributable to the Financial Services Businesses and the Closed Block Business, as well as allocations deemed reasonable by management in order to fairly present the financial position and results of operations of the Financial Services Businesses and the Closed Block Business on a stand alone basis. While management considers the allocations utilized to be reasonable, management has the discretion to make operational and financial decisions that may affect the allocation methods and resulting assets, liabilities, revenues and expenses of each business. In addition, management has limited discretion over accounting policies and the appropriate allocation of earnings between the two businesses. The Company is subject to agreements which provide that, in most instances, the Company may not change the allocation methodology or accounting policies for the allocation of earnings between the Financial Services Businesses and Closed Block Business without the prior consent of the Class B Stock holders or IHC debt bond insurer.

 

General corporate overhead not directly attributable to a specific business that has been incurred in connection with the generation of the businesses’ revenues is generally allocated between the Financial Services Businesses and the Closed Block Business based on the general and administrative expenses of each business as a percentage of the total general and administrative expenses for all businesses.

 

Prudential Holdings, LLC, a wholly owned subsidiary of Prudential Financial, Inc., has outstanding senior secured notes (the “IHC debt”), of which net proceeds of $1.66 billion were allocated to the Financial Services Businesses concurrent with the demutualization on December 18, 2001. The IHC debt is serviced by the cash flows of the Closed Block Business, and the results of the Closed Block Business reflect interest expense associated with the IHC debt.

 

Income taxes are allocated between the Financial Services Businesses and the Closed Block Business as if they were separate companies based on the taxable income or losses and other tax characterizations of each

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Supplemental Combining Financial Information—(Continued)

 

business. If a business generates benefits, such as net operating losses, it is entitled to record such tax benefits to the extent they are expected to be utilized on a consolidated basis.

 

Holders of Common Stock have no interest in a separate legal entity representing the Financial Services Businesses; holders of the Class B Stock have no interest in a separate legal entity representing the Closed Block Business; and holders of each class of common stock are subject to all of the risks associated with an investment in the Company.

 

In the event of a liquidation, dissolution or winding-up of the Company, holders of Common Stock and holders of Class B Stock would be entitled to receive a proportionate share of the net assets of the Company that remain after paying all liabilities and the liquidation preferences of any preferred stock.

 

The results of the Financial Services Businesses are subject to certain risks pertaining to the Closed Block. These include any expenses and liabilities from litigation affecting the Closed Block policies as well as the consequences of certain potential adverse tax determinations. In connection with the sale of the Class B Stock and IHC debt, the cost of indemnifying the investors with respect to certain matters will be borne by the Financial Services Businesses.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the consolidated financial condition of Prudential Financial as of March 31, 2007, compared with December 31, 2006, and its consolidated results of operations for the three months ended March 31, 2007 and March 31, 2006. You should read the following analysis of our consolidated financial condition and results of operations in conjunction with the MD&A, the “Risk Factors” section and the audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, as well as the statements under “Forward-Looking Statements” and the Unaudited Interim Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.

 

Overview

 

Prudential Financial has two classes of common stock outstanding. The Common Stock, which is publicly traded (NYSE:PRU), reflects the performance of the Financial Services Businesses, while the Class B Stock, which was issued through a private placement and does not trade on any exchange, reflects the performance of the Closed Block Business. The Financial Services Businesses and the Closed Block Business are discussed below.

 

Financial Services Businesses

 

Our Financial Services Businesses consist of three operating divisions, which together encompass eight segments, and our Corporate and Other operations. The Insurance division consists of our Individual Life, Individual Annuities and Group Insurance segments. The Investment division consists of our Asset Management, Financial Advisory and Retirement segments. The International Insurance and Investments division consists of our International Insurance and International Investments segments. Our Corporate and Other operations include our real estate and relocation services business, as well as corporate items and initiatives that are not allocated to business segments. Corporate and Other operations also include businesses that have been or will be divested and businesses that we have placed in wind-down status.

 

We attribute financing costs to each segment based on the amount of financing used by each segment, excluding financing costs associated with corporate debt. The net investment income of each segment includes earnings on the amount of equity that management believes is necessary to support the risks of that segment.

 

We seek growth internally and through acquisitions, joint ventures or other forms of business combinations or investments. Our principal acquisition focus is in our current business lines, both domestic and international.

 

Closed Block Business

 

In connection with the demutualization, we ceased offering domestic participating products. The liabilities for our traditional domestic in force participating products were segregated, together with assets, in a regulatory mechanism referred to as the “Closed Block.” The Closed Block is designed generally to provide for the reasonable expectations for future policy dividends after demutualization of holders of participating individual life insurance policies and annuities included in the Closed Block by allocating assets that will be used exclusively for payment of benefits, including policyholder dividends, expenses and taxes with respect to these products. See Note 4 to the Unaudited Interim Consolidated Financial Statements for more information on the Closed Block. At the time of demutualization, we determined the amount of Closed Block assets so that the Closed Block assets initially had a lower book value than the Closed Block liabilities. We expect that the Closed Block assets will generate sufficient cash flow, together with anticipated revenues from the Closed Block policies, over the life of the Closed Block to fund payments of all expenses, taxes, and policyholder benefits to be paid to, and the reasonable dividend expectations of, holders of the Closed Block policies. We also segregated for accounting purposes the assets that we need to hold outside the Closed Block to meet capital requirements related

 

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to the Closed Block policies. No policies sold after demutualization will be added to the Closed Block, and its in force business is expected to ultimately decline as we pay policyholder benefits in full. We also expect the proportion of our business represented by the Closed Block to decline as we grow other businesses.

 

Concurrently with our demutualization, Prudential Holdings, LLC, a wholly owned subsidiary of Prudential Financial that owns the capital stock of Prudential Insurance, issued $1.75 billion in senior secured notes, which we refer to as the IHC debt. The net proceeds from the issuances of the Class B Stock and IHC debt, except for $72 million used to purchase a guaranteed investment contract to fund a portion of the bond insurance cost associated with that debt, were allocated to the Financial Services Businesses. However, we expect that the IHC debt will be serviced by the net cash flows of the Closed Block Business over time, and we include interest expenses associated with the IHC debt when we report results of the Closed Block Business.

 

The Closed Block Business consists principally of the Closed Block, assets that we must hold outside the Closed Block to meet capital requirements related to the Closed Block policies, invested assets held outside the Closed Block that represent the difference between the Closed Block assets and Closed Block liabilities and the interest maintenance reserve, deferred policy acquisition costs related to Closed Block policies, the principal amount of the IHC debt and related hedging activities, and certain other related assets and liabilities.

 

Executive Summary

 

Prudential Financial, one of the largest financial services companies in the U.S., offers individual and institutional clients a wide array of financial products and services, including life insurance, annuities, mutual funds, pension and retirement-related services and administration, asset management, banking and trust services, real estate brokerage and relocation services, and, through a joint venture, retail securities brokerage services. We offer these products and services through one of the largest distribution networks in the financial services industry.

 

Significant developments and events in the first three months of 2007 reflect our continued efforts to redeploy capital effectively to seek enhanced returns, including the continuation of our share repurchase program. In the first three months of 2007, we repurchased 8.4 million shares of Common Stock at a total cost of $749 million and are authorized, under a stock repurchase program authorized by Prudential Financial’s Board of Directors in November 2006, to repurchase up to an additional $2.3 billion of Common Stock during 2007.

 

We analyze performance of the segments and Corporate and Other operations of the Financial Services Businesses using a measure called adjusted operating income. See “—Consolidated Results of Operations” for a definition of adjusted operating income and a discussion of its use as a measure of segment operating performance.

 

Shown below are the contributions of each segment and Corporate and Other operations to our adjusted operating income for the three months ended March 31, 2007 and 2006 and a reconciliation of adjusted operating income of our segments and Corporate and Other operations to income from continuing operations before income taxes and equity in earnings of operating joint ventures.

 

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Table of Contents
    

Three Months Ended

March 31,


 
         2007    

        2006    

 
     (in millions)  

Adjusted operating income before income taxes for segments of the Financial Services Businesses:

                

Individual Life

   $ 101     $ 133  

Individual Annuities

     166       118  

Group Insurance

     51       47  

Asset Management

     184       169  

Financial Advisory

     96       (66 )

Retirement

     148       137  

International Insurance

     413       338  

International Investments

     62       44  

Corporate and Other

     12       26  

Realized investment gains (losses), net, and related adjustments

     146       50  

Charges related to realized investment gains (losses), net

     (6 )     —    

Investment gains (losses) on trading account assets supporting insurance liabilities, net

     82       (114 )

Change in experience-rated contractholder liabilities due to asset value changes

     (62 )     66  

Divested businesses

     19       13  

Equity in earnings of operating joint ventures

     (120 )     (78 )
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures for Financial Services Businesses

     1,292       883  

Income from continuing operations before income taxes and equity in earnings of operating joint ventures for Closed Block Business

     137       84  
    


 


Consolidated income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 1,429     $ 967  
    


 


 

Results for the three months ended March 31, 2007 presented above reflect the following:

 

   

Individual Life segment results for the first quarter of 2007 decreased from the prior year period primarily due to less favorable mortality experience, net of reinsurance.

 

   

Individual Annuities segment results for the first quarter of 2007 improved in comparison to the prior year quarter due to higher fee income reflecting higher average asset balances as well as a contribution from the variable annuity business acquired from The Allstate Corporation on June 1, 2006.

 

   

Group Insurance segment results for the first quarter of 2007 increased from the prior year period, as more favorable claims experience in our group life business and a greater contribution from investment results were partially offset by higher operating expenses and less favorable claims experience in our group disability business.

 

   

Asset Management segment results in the first quarter of 2007 improved in comparison to the prior year quarter, primarily reflecting higher asset based fees as a result of increased asset values due to market appreciation and net asset flows.

 

   

Financial Advisory segment results improved in the first quarter of 2007 in comparison to the prior year quarter, reflecting lower expenses in the first quarter of 2007 related to obligations and costs we retained in connection with the businesses contributed to the retail brokerage joint venture with Wachovia, primarily for litigation and regulatory matters, and increased income from our 38% share of the joint venture. Our share of the joint venture results increased $42 million reflecting a strong current quarter contribution from equity syndication activities, as well as increased fee based income.

 

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Retirement segment results for the first quarter of 2007 increased from the prior year period, reflecting a greater contribution from investment results due primarily to a larger base of invested assets and higher portfolio yields, as well as increased fees due to higher full service retirement account values primarily resulting from market appreciation.

 

   

International Insurance segment results for the first quarter of 2007 improved in comparison to the first quarter of 2006, reflecting more favorable results from the segment’s Life Planner operations, which benefited from continued business growth, increased investment income margins, and more favorable foreign currency exchange rates. Results from the segment’s Gibraltar Life operation also improved from the first quarter of 2006 to the first quarter of 2007 reflecting improved investment income margins, growth in our U.S. dollar denominated annuity product, and a more favorable level of policyholders’ benefits and expenses.

 

   

International Investments segment results for the first quarter of 2007 increased from the prior year period primarily due to more favorable results from our Korean asset management operations, as well as more favorable sales and trading results from our global commodities group business.

 

   

Realized investment gains (losses), net, and related adjustments for the Financial Services Businesses in the first quarter of 2007 amounted to $146 million, reflecting net gains on sales of equity securities primarily by our Japanese insurance operations.

 

   

Income from continuing operations before income taxes and equity in earnings of operating joint ventures in the Closed Block Business increased $53 million, reflecting an increase in net realized investment gains of $147 million, partially offset by an increase in dividends to policyholders of $80 million. Net realized investment gains in the first quarter of 2007, reflect higher net gains from fixed maturities and equities, as well as more favorable fluctuations in the value of investment hedges.

 

Accounting Policies & Pronouncements

 

Accounting Pronouncements Adopted

 

See Note 2 to the Unaudited Interim Consolidated Financial Statements for a discussion of recently adopted accounting pronouncements, including the effect of adopting FASB Staff Position No. 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction”, AICPA Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts,” and FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.”

 

Recent Accounting Pronouncements

 

See Note 2 to the Unaudited Interim Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

 

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Consolidated Results of Operations

 

The following table summarizes income from continuing operations for the Financial Services Businesses and the Closed Block Business as well as other components comprising net income.

 

     Three Months Ended
March 31,


 
         2007    

        2006    

 
     (in millions)  

Financial Services Businesses by segment:

                

Individual Life

   $ 89     $ 118  

Individual Annuities

     158       112  

Group Insurance

     65       54  
    


 


Total Insurance Division

     312       284  

Asset Management

     186       169  

Financial Advisory

     (15 )     (135 )

Retirement

     158       84  
    


 


Total Investment Division

     329       118  

International Insurance

     547       364  

International Investments

     53       36  
    


 


Total International Insurance and Investments Division

     600       400  

Corporate and Other

     51       81  
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures for Financial Services Businesses

     1,292       883  

Income tax expense

     380       253  
    


 


Income from continuing operations before equity in earnings of operating joint ventures for Financial Services Businesses

     912       630  

Equity in earnings of operating joint ventures, net of taxes

     77       51  
    


 


Income from continuing operations for Financial Services Businesses

     989       681  

Income (loss) from discontinued operations, net of taxes

     36       (6 )
    


 


Net income – Financial Services Businesses

   $ 1,025     $ 675  
    


 


Basic income from continuing operations per share – Common Stock

   $ 2.14     $ 1.42  

Diluted income from continuing operations per share – Common Stock

   $ 2.10     $ 1.39  

Basic net income per share – Common Stock

   $ 2.22     $ 1.40  

Diluted net income per share – Common Stock

   $ 2.18     $ 1.38  

Closed Block Business:

                

Income from continuing operations before income taxes for Closed Block Business

   $ 137     $ 84  

Income tax expense

     44       26  
    


 


Income from continuing operations for Closed Block Business

     93       58  

Income (loss) from discontinued operations, net of taxes

     2       —    
    


 


Net income – Closed Block Business

   $ 95     $ 58  
    


 


Basic and diluted income from continuing operations per share – Class B Stock

   $ 39.00     $ 19.50  

Basic and diluted net income per share – Class B Stock

   $ 40.00     $ 19.50  

Consolidated:

                
    


 


Net income

   $ 1,120     $ 733  
    


 


 

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Results of Operations – Financial Services Businesses

 

2007 to 2006 Three Month Comparison. Income from continuing operations attributable to the Financial Services Businesses of $989 million increased over the first quarter of 2006 by $308 million. This increase resulted from continued growth of international insurance operations, higher asset based fees including the results of the business we acquired from Allstate in the second quarter of 2006, improved investment results, and lower general and administrative expenses primarily due to lower retained costs in connection with our joint venture with Wachovia. On a diluted per share basis, income from continuing operations attributable to the Financial Services Businesses for the quarter ended March 31, 2007 of $2.10 per share of Common Stock increased from $1.39 per share of Common Stock for the quarter ended March 31, 2006. This increase reflects the growth in earnings discussed above, in addition to the benefit of a lower number of shares of Common Stock outstanding due to our share repurchase program. We analyze the operating performance of the segments included in the Financial Services Businesses using “adjusted operating income” as described in “—Segment Measures,” below. For a discussion of our segment results on this basis see “—Results of Operations for Financial Services Businesses by Segment,” below.

 

The direct equity adjustment increased income from continuing operations available to holders of the Common Stock for earnings per share purposes by $15 million for the quarter ended March 31, 2007, compared to $19 million for the quarter ended March 31, 2006. The direct equity adjustment modifies earnings available to holders of the Common Stock and the Class B Stock for earnings per share purposes. The holders of the Common Stock will benefit from the direct equity adjustment as long as reported administrative expenses of the Closed Block Business are less than the cash flows for administrative expenses determined by the policy servicing fee arrangement that is based upon insurance and policies in force and statutory cash premiums. As statutory cash premiums and policies in force in the Closed Block Business decline, we expect the benefit to the Common Stock holders from the direct equity adjustment to decline accordingly. If the reported administrative expenses of the Closed Block Business exceed the cash flows for administrative expenses determined by the policy servicing fee arrangement, the direct equity adjustment will reduce income available to holders of the Common Stock for earnings per share purposes.

 

Results of Operations – Closed Block Business

 

2007 to 2006 Three Month Comparison. Income from continuing operations attributable to the Closed Block Business for the quarter ended March 31, 2007, was $93 million, or $39.00 per share of Class B Stock, compared to $58 million, or $19.50 per share of Class B Stock, for the quarter ended March 31, 2006. The direct equity adjustment decreased income from continuing operations available to the Class B Stock holders for earnings per share purposes by $15 million for the quarter ended March 31, 2007, compared to $19 million for the quarter ended March 31, 2006. For a discussion of the results of operations for the Closed Block Business, see “—Results of Operations of Closed Block Business,” below.

 

Segment Measures

 

In managing our business, we analyze operating performance separately for our Financial Services Businesses and our Closed Block Business. For the Financial Services Businesses, we analyze our segments’ operating performance using “adjusted operating income.” Results of the Closed Block Business for all periods are evaluated and presented only in accordance with U.S. GAAP. Adjusted operating income does not equate to “income from continuing operations before income taxes and equity in earnings of operating joint ventures” or “net income” as determined in accordance with U.S. GAAP but is the measure of segment profit or loss we use to evaluate segment performance and allocate resources, and consistent with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” is our measure of segment performance. Adjusted operating income is calculated for the segments of the Financial Services Businesses by adjusting each segment’s “income from continuing operations before income taxes and equity in earnings of operating joint ventures” for the following items:

 

   

realized investment gains (losses), net, except as indicated below, and related charges and adjustments;

 

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Table of Contents
   

net investment gains and losses on trading account assets supporting insurance liabilities and changes in experience-rated contractholder liabilities due to asset value changes;

 

   

the contribution to income/loss of divested businesses that have been or will be sold or exited that do not qualify for “discontinued operations” accounting treatment under U.S. GAAP; and

 

   

equity in earnings of operating joint ventures.

 

The items above are important to an understanding of our overall results of operations. Adjusted operating income is not a substitute for income determined in accordance with U.S. GAAP, and our definition of adjusted operating income may differ from that used by other companies. However, we believe that the presentation of adjusted operating income as we measure it for management purposes enhances understanding of our results of operations by highlighting the results from ongoing operations and the underlying profitability of the Financial Services Businesses. Adjusted operating income excludes “Realized investment gains (losses), net,” except as indicated below, and related charges and adjustments. A significant element of realized investment gains and losses are impairments and credit-related and interest rate-related gains and losses. Impairments and losses from sales of credit-impaired securities, the timing of which depends largely on market credit cycles, can vary considerably across periods. The timing of other sales that would result in gains or losses, such as interest rate-related gains or losses, is largely subject to our discretion and influenced by market opportunities, as well as our tax profile. Trends in the underlying profitability of our businesses can be more clearly identified without the fluctuating effects of these transactions. Similarly, adjusted operating income excludes investment gains and losses on trading account assets supporting insurance liabilities and changes in experience-rated contractholder liabilities due to asset value changes, because these recorded changes in asset and liability values will ultimately accrue to the contractholders. Adjusted operating income excludes the results of divested businesses because they are not relevant to understanding our ongoing operating results. The contributions to income/loss of wind-down businesses that we have not divested remain in adjusted operating income. See Note 8 to the Unaudited Interim Consolidated Financial Statements for further information on the presentation of segment results.

 

As noted above, certain “Realized investment gains (losses), net,” are included in adjusted operating income. We include in adjusted operating income the portion of our realized investment gains and losses on derivatives that arise from the termination of contracts used to hedge our foreign currency earnings in the same period that the expected earnings emerge. Similarly, we include in adjusted operating income the portion of our realized investment gains and losses on derivatives that represent current period yield adjustments. The realized investment gains or losses from products that are free standing derivatives, or contain embedded derivatives, along with the realized investment gains or losses from associated derivative portfolios that are part of an economic hedging program related to the risk of these products, are included in adjusted operating income. Adjusted operating income also includes for certain embedded derivatives, as current period yield adjustments, a portion of the cumulative realized investment gains, on an amortized basis over the remaining life of the related security, or cumulative realized investment losses in the period incurred. Adjusted operating income also includes those realized investment gains and losses that represent profit or loss of certain of our businesses which primarily originate investments for sale or syndication to unrelated investors.

 

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Table of Contents

Results of Operations for Financial Services Businesses by Segment

 

Insurance Division

 

Individual Life

 

Operating Results

 

The following table sets forth the Individual Life segment’s operating results for the periods indicated.

 

     Three Months Ended
March 31,


 
         2007    

        2006    

 
     (in millions)  

Operating results:

                

Revenues

   $ 631     $ 559  

Benefits and expenses

     530       426  
    


 


Adjusted operating income

     101       133  

Realized investment gains (losses), net, and related adjustments(1)

     (12 )     (15 )
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 89     $ 118  
    


 



(1) Revenues exclude Realized investment gains (losses), net, and related adjustments. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income decreased $32 million from $133 million in the first quarter of 2006 to $101 million in the first quarter of 2007. The decline in adjusted operating income primarily reflects less favorable mortality experience, net of reinsurance, compared to the first quarter of the prior year.

 

Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased by $72 million, from $559 million in the first quarter of 2006 to $631 million in the first quarter of 2007. Premiums increased $26 million, primarily due to increased premiums on term life insurance reflecting continued growth of our in force block of term insurance. Net investment income increased $29 million, reflecting higher asset balances primarily from financing of regulatory reserves discussed below and higher yields in the current period. Policy charges and fee income increased $6 million, reflecting the continuing growth in our universal life book of business.

 

Benefits and Expenses

 

2007 to 2006 Three Month Comparison. Benefits and expenses, as shown in the table above under “—Operating Results,” increased $104 million, from $426 million in the first quarter of 2006 to $530 million in the first quarter of 2007. Policyholders’ benefits, including interest credited to policyholders’ account balances, increased $81 million, due to less favorable mortality experience compared to the prior year period and increases in reserves on term life insurance associated with growth in our in force block of term insurance. Interest expense increased $21 million, primarily reflecting interest on borrowings related to the financing of regulatory reserves required to be held for certain term and universal life insurance policies.

 

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Table of Contents

Sales Results

 

The following table sets forth individual life insurance business sales, as measured by scheduled premiums from new sales on an annualized basis and first year excess premiums and deposits on a cash-received basis, for the periods indicated. Sales of the individual life insurance business do not correspond to revenues under U.S. GAAP. They are, however, a relevant measure of business activity. In managing our individual life insurance business, we analyze new sales on this basis because it measures the current sales performance of the business, while revenues primarily reflect the renewal persistency and aging of in force policies written in prior years and net investment income as well as current sales.

 

    

Three Months Ended

March 31,


     2007

   2006

     (in millions)

Life insurance sales(1):

             

Excluding corporate-owned life insurance:

             

Variable life

   $ 48    $ 21

Universal life

     44      40

Term life

     49      31
    

  

Total excluding corporate-owned life insurance

     141      92

Corporate-owned life insurance

     5      1
    

  

Total

   $ 146    $ 93
    

  

Life Insurance sales by distribution channel, excluding corporate-owned life insurance(1):

             

Prudential Agents

   $ 42    $ 45

Third party

     99      47
    

  

Total

   $ 141    $ 92
    

  


(1) Scheduled premiums from new sales on an annualized basis and first year excess premiums and deposits on a cash-received basis.

 

2007 to 2006 Three Month Comparison. Sales of new life insurance, excluding corporate-owned life insurance, measured as described above, increased $49 million, from $92 million in the first quarter of 2006 to $141 million in the first quarter of 2007. Sales of variable and term life products increased $45 million, which included the benefit of several large variable life product sales in the current period.

 

The increase in sales of life insurance, excluding corporate-owned life insurance, was driven by a $52 million increase in sales from the third party distribution channel across all product lines. The increase was partially offset by decreased sales by Prudential Agents of $3 million, reflecting a decline in the number of agents from 2,850 at March 31, 2006 to 2,505 at March 31, 2007.

 

Policy Surrender Experience

 

The following table sets forth the individual life insurance business’ policy surrender experience for variable and universal life insurance, measured by cash value of surrenders, for the periods indicated. These amounts do not correspond to expenses under U.S. GAAP. In managing this business, we analyze the cash value of surrenders because it is a measure of the degree to which policyholders are maintaining their in force business with us, a driver of future profitability. Generally, our term life insurance products do not provide for cash surrender values.

 

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Table of Contents
     Three Months Ended
March 31,


 
       2007  

      2006  

 
     (in millions)  

Cash value of surrenders

   $ 167     $ 191  
    


 


Cash value of surrenders as a percentage of mean future benefit reserves, policyholders’ account balances, and separate account balances

     3.0 %     3.7 %
    


 


 

2007 to 2006 Three Month Comparison. The total cash value of surrenders decreased $24 million, from $191 million in the first quarter of 2006 to $167 million in the first quarter of 2007, as the prior year quarter included the surrender of a single large corporate-owned life insurance case, resulting in the current quarter decrease in the level of surrenders as a percentage of mean future policy benefit reserves, policyholders’ account balances and separate account balances.

 

Individual Annuities

 

Operating Results

 

The following table sets forth the Individual Annuities segment’s operating results for the periods indicated.

 

     Three Months Ended
March 31,


 
       2007  

      2006  

 
     (in millions)  

Operating results:

                

Revenues

   $ 604     $ 453  

Benefits and expenses

     438       335  
    


 


Adjusted operating income

     166       118  

Realized investment gains (losses), net, and related adjustments(1)

     (8 )     (7 )

Related charges(1)(2)

     —         1  
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 158     $ 112  
    


 



(1) Revenues exclude Realized investment gains (losses), net, and related charges and adjustments. The related charges represent payments related to the market value adjustment features of certain of our annuity products. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”
(2) Benefits and expenses exclude related charges which represent the unfavorable (favorable) impact of Realized investment gains (losses), net, on change in reserves and the amortization of deferred policy acquisition costs, deferred sales inducements and value of business acquired.

 

On June 1, 2006, we acquired the variable annuity business of The Allstate Corporation, or Allstate, through a reinsurance transaction for $635 million of total consideration, consisting primarily of a $628 million ceding commission. Our initial investment in the business was approximately $600 million, consisting of the total consideration, offset by the related tax benefits, plus an additional contribution of $94 million to meet regulatory capital requirements. See Note 3 to the Unaudited Interim Consolidated Financial Statements for further discussion of this acquisition.

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income increased $48 million, from $118 million in the first quarter of 2006 to $166 million in the first quarter of 2007, including a $23 million contribution in the first quarter 2007 from the variable annuity business acquired from Allstate. The remainder of

 

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the increase came primarily from higher fee income driven by higher average asset balances from market appreciation and positive net asset flows. Partially offsetting these items was an increase in amortization of deferred policy acquisition and other costs reflecting increased gross profits in the current period. The contribution of the acquired Allstate business to adjusted operating income for the first quarter of 2007 consists of revenues of $96 million and benefits and expenses of $73 million. Revenues from the acquired business consisted primarily of policy charges and fees of $63 million, net investment income of $17 million and asset management fees and other income of $15 million. Benefits and expenses from this business consisted primarily of general and administrative expenses, net of capitalization of $49 million and policyholders’ benefits, including interest credited to policyholders’ account balances, of $23 million.

 

Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $151 million, from $453 million in the first quarter of 2006 to $604 million in the first quarter of 2007, including revenues of $96 million from the variable annuity business acquired from Allstate. The remainder of the increase in revenues came primarily from increases in policy charges and fees and asset management fees and other income reflecting an increase in the average market value of variable annuity account values as well as positive net flows. Partially offsetting these items was a decrease in net investment income, excluding the impact from the business acquired from Allstate, primarily from the shift in customer funds from fixed income investments to variable investments.

 

Benefits and Expenses

 

2007 to 2006 Three Month Comparison. Benefits and expenses, as shown in the table above under “—Operating Results,” increased $103 million, from $335 million in the first quarter of 2006 to $438 million in the first quarter of 2007, including benefits and expenses of $73 million from the variable annuity business acquired from Allstate. In addition, general and administrative expenses, net of capitalization, increased reflecting higher distribution and asset management costs associated with increased variable annuity sales and growth in variable annuity account values, as well as growth of the business. Amortization of deferred policy acquisition costs increased, reflecting increased gross profits in the current period.

 

Account Values

 

The following table sets forth changes in account values for the individual annuity business, for the periods indicated. For our individual annuity business, assets are reported at account value, and net sales (redemptions) are gross sales minus redemptions or surrenders and withdrawals, as applicable.

 

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Three Months Ended

March 31,


 
     2007

    2006

 
     (in millions)  

Variable Annuities(1):

                

Beginning total account value

   $ 74,555     $ 50,778  

Sales

     2,779       2,129  

Surrenders and withdrawals

     (2,310 )     (1,585 )
    


 


Net sales

     469       544  

Benefit payments

     (306 )     (185 )
    


 


Net flows

     163       359  

Change in market value, interest credited and other activity

     1,168       2,228  

Policy charges

     (295 )     (184 )
    


 


Ending total account value(2)

   $ 75,591     $ 53,181  
    


 


Fixed Annuities:

                

Beginning total account value

   $ 3,748     $ 3,991  

Sales

     21       28  

Surrenders and withdrawals

     (81 )     (69 )
    


 


Net redemptions

     (60 )     (41 )

Benefit payments

     (43 )     (43 )
    


 


Net flows

     (103 )     (84 )

Interest credited and other activity

     35       35  

Policy charges

     (1 )     (1 )
    


 


Ending total account value

   $ 3,679     $ 3,941  
    


 



(1) Variable annuities include only those sold as retail investment products. Investments through defined contribution plan products are included with such products within the Retirement segment.
(2) As of March 31, 2007, variable annuity account values are invested in equity funds ($41 billion or 54%), balanced funds ($15 billion or 19%), bond funds ($9 billion or 12%), and other ($11 billion or 15%).

 

2007 to 2006 Three Month Comparison. Total account values for fixed and variable annuities amounted to $79.3 billion as of March 31, 2007, an increase of $1.0 billion from December 31, 2006. The increase came primarily from increases in the market value of customers’ variable annuities and positive variable annuity net flows. Total account values as of March 31, 2007 increased $22.1 billion from March 31, 2006, primarily reflecting $16.3 billion of variable annuity account values acquired from Allstate, as well as increases in the market value of customers’ variable annuities and positive variable annuity net flows. Individual variable annuity gross sales increased by $650 million, from $2.1 billion in the first quarter of 2006 to $2.8 billion in the first quarter of 2007, reflecting sales of $448 million related to the business acquired from Allstate and growth of our distribution relationships. Individual variable annuity surrenders and withdrawals increased by $725 million, from $1.6 billion in the first quarter of 2006 to $2.3 billion in the first quarter of 2007, including $574 million of surrenders and withdrawals in the current quarter related to the business acquired from Allstate, as well as the impact of higher average account values due to market appreciation.

 

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Table of Contents

Group Insurance

 

Operating Results

 

The following table sets forth the Group Insurance segment’s operating results for the periods indicated.

 

     Three Months
Ended March 31,


 
     2007

   2006

 
     (in millions)  

Operating results:

               

Revenues

   $ 1,205    $ 1,109  

Benefits and expenses

     1,154      1,062  
    

  


Adjusted operating income

     51      47  

Realized investment gains (losses), net, and related adjustments(1)

     14      8  

Related charges(2)

     —        (1 )
    

  


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 65    $ 54  
    

  



(1) Revenues exclude Realized investment gains (losses), net, and related adjustments. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”
(2) Benefits and expenses exclude related charges which represent the unfavorable (favorable) impact of Realized investment gains (losses), net, on interest credited to policyholders’ account balances.

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income increased $4 million, from $47 million in the first quarter of 2006 to $51 million in the first quarter of 2007. This increase primarily reflects more favorable claims experience in our group life business and a greater contribution from investment results primarily reflecting growth in invested assets. Partially offsetting these increases were higher operating expenses primarily reflecting growth in the business and less favorable claims experience in our group disability business.

 

Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased by $96 million, from $1.109 billion in the first quarter of 2006 to $1.205 billion in the first quarter of 2007. Group life premiums increased by $37 million from $682 million in the first quarter of 2006 to $719 million in the first quarter of 2007, reflecting increased premiums on experience-rated group life business which have a corresponding increase in policyholder benefits discussed below. Persistency remained strong, but deteriorated slightly from 97% in the first quarter of 2006 to 96% in the first quarter of 2007. Group disability premiums, which include long-term care products, increased by $22 million from $185 million in the first quarter of 2006 to $207 million in the first quarter of 2007, primarily reflecting growth in business in force resulting from new sales and continued strong persistency, which deteriorated slightly from 94% in the first quarter of 2006 to 92% in the first quarter of 2007. In addition, policy charges and fee income increased by $19 million primarily reflecting growth of business in force. Net investment income also increased $16 million primarily reflecting a larger base of invested assets due to business growth.

 

Benefits and Expenses

 

The following table sets forth the Group Insurance segment’s benefits and administrative operating expense ratios for the periods indicated.

 

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Three Months Ended

March 31,


 
      2007 

     2006 

 

Benefits ratio(1):

            

Group life

   91.5 %   92.1 %

Group disability

   91.0     87.3  

Administrative operating expense ratio(2):

            

Group life

   9.6     9.4  

Group disability

   22.1     21.6  

(1) Ratio of policyholder benefits to earned premiums, policy charges and fee income. Group disability ratios include long-term care products.
(2) Ratio of administrative operating expenses (excluding commissions) to gross premiums, policy charges and fee income. Group disability ratios include long-term care products.

 

2007 to 2006 Three Month Comparison. Benefits and expenses, as shown in the table above under “—Operating Results,” increased by $92 million, from $1.062 billion in the first quarter of 2006 to $1.154 billion in the first quarter of 2007. The increase was primarily driven by an increase of $75 million in policyholders’ benefits, including the change in policy reserves, reflecting greater benefits on experience-rated group life business which, as discussed above, result in increased premiums, and the growth of business in force. Also contributing to the increase in benefits and expenses were higher operating expenses primarily reflecting growth in the business.

 

The group life benefits ratio improved 0.6 percentage points from the first quarter of 2006 to the first quarter of 2007, reflecting more favorable mortality experience in our group life business. The group disability benefits ratio deteriorated 3.7 percentage points from the first quarter of 2006 to the first quarter of 2007, due to less favorable claims experience in our group disability business. The group life and group disability administrative operating expense ratios were relatively unchanged from the first quarter of 2006 to the first quarter of 2007, as the increase in operating expenses was commensurate with the related increase in revenue from growth in the business.

 

Sales Results

 

The following table sets forth the Group Insurance segment’s new annualized premiums for the periods indicated. In managing our group insurance business, we analyze new annualized premiums, which do not correspond to revenues under U.S. GAAP, because new annualized premiums measure the current sales performance of the business unit, while revenues primarily reflect the renewal persistency and aging of in force policies written in prior years and net investment income, in addition to current sales.

 

    

Three Months Ended

March 31,


       2007  

     2006  

     (in millions)

New annualized premiums(1):

             

Group life

   $ 103    $ 206

Group disability(2)

     92      74
    

  

Total

   $ 195    $ 280
    

  


(1) Amounts exclude new premiums resulting from rate changes on existing policies, from additional coverage under our Servicemembers’ Group Life Insurance contract and from excess premiums on group universal life insurance that build cash value but do not purchase face amounts, and include premiums from the takeover of claim liabilities.
(2) Includes long-term care products.

 

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2007 to 2006 Three Month Comparison. Total new annualized premiums decreased $85 million, or 30%, from $280 million in the first quarter of 2006 to $195 million in the first quarter of 2007. This decrease is primarily attributable to lower large case sales in the group life business in the first quarter of 2007. Partially offsetting this decrease were higher large case and middle-market sales in the group disability business during the first quarter of 2007.

 

Investment Division

 

Asset Management

 

Operating Results

 

The following table sets forth the Asset Management segment’s operating results for the periods indicated.

 

     Three Months Ended
March 31,


       2007  

     2006  

     (in millions)

Operating results:

             

Revenues

   $ 557    $ 502

Expenses

     373      333
    

  

Adjusted operating income

     184      169

Realized investment gains, net, and related adjustments(1)

     2      —  
    

  

Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 186    $ 169
    

  


(1) Revenues exclude Realized investment gains (losses), net, and related adjustments. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income increased $15 million, from $169 million in the first quarter of 2006 to $184 million in the first quarter of 2007. Results for the first quarter of 2007 benefited from increased asset management fees of $28 million, primarily from the management of institutional and retail customer assets as a result of increased asset values due to market appreciation and net asset flows. Higher expenses, primarily reflecting performance-based compensation, were a partial offset to the growth in fees. Results of the segment’s proprietary investing business were essentially unchanged in the current quarter compared to the prior year quarter. Current quarter results included income of $20 million from changes in market value in a fixed income fund, which essentially offset lower income from real estate related investments in that business.

 

Revenues

 

The following tables set forth the Asset Management segment’s revenues, presented on a basis consistent with the table above under “—Operating Results,” by type, asset management fees by source and assets under management for the periods indicated. In managing our business we analyze assets under management, which do not correspond to U.S. GAAP assets, because a principal source of our revenues are fees based on assets under management. The presentation of revenues below has been revised from the presentation in prior period reports to reflect revenues by type.

 

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     Three Months Ended
March 31,


       2007  

     2006  

     (in millions)

Revenues by type:

             

Asset management fees

   $ 262    $ 234

Incentive, transaction, principal investing and capital markets revenues

     143      144

Service, distribution and other revenues(1)

     152      124
    

  

Total revenues

   $ 557    $ 502
    

  


(1) Includes revenues under a contractual arrangement with Wachovia Securities, related to managed account services, which was originally scheduled to expire on July 1, 2006. This contract was amended effective July 1, 2005 to provide essentially a fixed fee for managed account services and is now scheduled to expire on July 1, 2008. Also includes payments from Wachovia Corporation under an agreement dated as of July 30, 2004 implementing arrangements with respect to money market mutual funds in connection with the combination of our retail securities brokerage and clearing operations with those of Wachovia Corporation. The agreement extends for ten years after termination of the joint venture. The revenue from Wachovia Corporation under this agreement was $13 million and $14 million in the three months ended March 31, 2007 and 2006, respectively.

 

    

Three Months Ended

March 31,


       2007  

     2006  

     (in millions)

Asset management fees by source:

             

Institutional customers

   $ 117    $ 98

Retail customers(1)

     84      76

General account

     61      60
    

  

Total revenues

   $ 262    $ 234
    

  


(1) Consists of individual mutual funds and both variable annuities and variable life insurance asset management revenues from our separate accounts. This also includes funds invested in proprietary mutual funds through our defined contribution plan products. Revenues from fixed annuities and the fixed rate options of both variable annuities and variable life insurance are included in the general account.

 

     March 31,
2007


  

March 31,

2006


     (in billions)

Assets Under Management (at fair market value):

             

Institutional customers(1)

   $ 161.0    $ 138.7

Retail customers(2)

     84.2      75.6

General account

     168.9      157.8
    

  

Total

   $ 414.1    $ 372.1
    

  


(1) Consists of third party institutional assets and group insurance contracts.
(2) Consists of individual mutual funds and both variable annuities and variable life insurance assets in our separate accounts. This also includes funds invested in proprietary mutual funds through our defined contribution plan products. Fixed annuities and the fixed rate options of both variable annuities and variable life insurance are included in the general account.

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $55 million, from $502 million in the first quarter of 2006 to $557 million in the first quarter of 2007. Asset management fees increased $28 million primarily from the management of institutional and retail

 

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customer assets as a result of increased asset values due to market appreciation and net asset flows. Revenues from incentive, transaction, principal investing and capital markets revenues were essentially unchanged, reflecting greater revenues from proprietary investing mainly due to changes in market value in a fixed income fund, which essentially offset lower income from real estate related investments in that business. Certain of our incentive fees are subject to positive or negative future adjustment based on cumulative fund performance in relation to specified benchmarks. Service, distribution and other revenues increased $28 million primary due to increased revenues in certain real estate funds, which is fully offset by higher expenses related to minority interest in these funds.

 

Expenses

 

2007 to 2006 Three Month Comparison. Expenses, as shown in the table above under “—Operating Results,” increased $40 million, from $333 million in the first quarter of 2006 to $373 million in the first quarter of 2007. The increase in expenses is due to higher performance based compensation costs resulting from favorable performance in the first quarter of 2007, as well as increased expenses associated with certain real estate funds, as discussed above.

 

Financial Advisory

 

Operating Results

 

The following table sets forth the Financial Advisory segment’s operating results for the periods indicated.

 

    

Three Months Ended

March 31,


 
       2007  

      2006  

 
     (in millions)  

Operating results:

                

Revenues

   $ 157     $ 178  

Expenses

     61       244  
    


 


Adjusted operating income

     96       (66 )

Equity in earnings of operating joint ventures(1)

     (111 )     (69 )
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ (15 )   $ (135 )
    


 



(1) Equity in earnings of operating joint ventures are included in adjusted operating income but excluded from income from continuing operations before income taxes and equity in earnings of operating joint ventures as they are reflected on a U.S. GAAP basis on an after-tax basis as a separate line in our Unaudited Interim Consolidated Statements of Operations.

 

On July 1, 2003, we combined our retail securities brokerage and clearing operations with those of Wachovia Corporation, or Wachovia, and formed Wachovia Securities Financial Holdings, LLC, or Wachovia Securities, a joint venture headquartered in Richmond, Virginia. We have a 38% ownership interest in the joint venture, while Wachovia owns the remaining 62%. The transaction included our securities brokerage operations but did not include our equity sales, trading and research operations. As part of the transaction we retained certain assets and liabilities related to the contributed businesses, including liabilities for certain litigation and regulatory matters. We account for our 38% ownership of the joint venture under the equity method of accounting.

 

2007 to 2006 Three Month Comparison. Adjusted operating income increased $162 million, from a loss of $66 million in the first quarter of 2006 to income of $96 million in the first quarter of 2007. The segment’s results for the first quarter of 2007 include our share of earnings from Wachovia Securities, on a pre-tax basis, of

 

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$111 million, compared to $69 million in the first quarter of 2006 reflecting a strong current quarter contribution from equity syndication activities, as well as increased fee based income. The segment’s results also include expenses of $14 million in the first quarter of 2007 related to obligations and costs we retained in connection with the contributed businesses primarily for litigation and regulatory matters, compared to $176 million in the first quarter of 2006. The prior year expenses reflect an increase in our reserve for settlement costs related to market timing issues involving the former Prudential Securities operations, with respect to which a settlement was reached in August 2006. In addition, results of the segment include a loss of $1 million in the first quarter of 2007 from our equity sales and trading operations, compared to income of $41 million in the first quarter of 2006. The prior year results include income of $42 million from securities relating to trading exchange memberships, primarily representing shares received in connection with the commencement of public trading of exchange shares. The majority of those shares were transferred to our corporate operations during the first quarter of 2006. Subsequent to this transfer, changes in market value of the transferred shares are reflected within Corporate and Other results.

 

Retirement

 

Operating Results

 

The following table sets forth the Retirement segment’s operating results for the periods indicated.

 

    

Three Months Ended

March 31,


 
         2007    

        2006    

 
     (in millions)  

Operating results:

                

Revenues

   $ 1,163     $ 1,054  

Benefits and expenses

     1,015       917  
    


 


Adjusted operating income

     148       137  

Realized investment gains (losses), net, and related adjustments(1)

     (7 )     (5 )

Related charges(2)

     (1 )     —    

Investment gains (losses) on trading account assets supporting insurance liabilities, net(3)

     58       (145 )

Change in experience-rated contractholder liabilities due to asset value changes(4)

     (40 )     97  
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 158     $ 84  
    


 



(1) Revenues exclude Realized investment gains (losses), net, and related adjustments. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”
(2) Benefits and expenses exclude related charges which represent the unfavorable (favorable) impact of Realized investment gains (losses), net, on change in reserves and the amortization of deferred policy acquisition costs.
(3) Revenues exclude net investment gains and losses on trading account assets supporting insurance liabilities. See “—Trading account assets supporting insurance liabilities.”
(4) Benefits and expenses exclude changes in contractholder liabilities due to asset value changes in the pool of investments supporting these experience-rated contracts. See “—Trading account assets supporting insurance liabilities.”

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income for the Retirement segment increased $11 million, from $137 million in the first quarter of 2006 to $148 million in the first quarter of 2007, reflecting higher adjusted operating income in our full service business. This business benefited from increased fees due to

 

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higher full service retirement account values and the lack of transition expenses in the current period, as the prior year period included $6 million of transition expenses related to the completion of the integration of the retirement business acquired from CIGNA. In addition, the contribution from investment results in the full service business was slightly lower in the current period primarily due to higher crediting rates on general account liabilities, partially offset by higher portfolio yields. The adjusted operating income from our institutional investment products business was relatively flat as a greater contribution from investment results primarily due to a larger base of invested assets and higher portfolio yields, was offset by reserve refinements reflecting updates of client census data on a group annuity block of business and less favorable retirement and mortality experience. Contributing to the higher portfolio yields is the benefit from the sale of lower yielding bonds and reinvestment of proceeds at higher available interest rates. The realized investment losses generated from these sales are excluded from adjusted operating income. For a discussion of realized investment gains and losses, including those related to changes in interest rates, see “—Realized Investment Gains and Losses and General Account Investments—Realized Investment Gains.”

 

Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $109 million, from $1.054 billion in the first quarter of 2006 to $1.163 billion in the first quarter of 2007. Net investment income increased $96 million, of which $24 million is due to the change in the reinsurance arrangement with respect to the guaranteed cost business acquired from CIGNA. Due to this change the results of this business, which were previously presented on a net basis in “Asset management fees and other income” are, beginning on April 1, 2006, presented on a gross basis in our results of operations. The remainder of the increase in net investment income primarily reflects a larger base of invested assets due to sales of guaranteed investment products in the institutional and retail markets and higher portfolio yields. Asset management fees and other income also increased $13 million reflecting growth in fees due to higher full service retirement account values primarily resulting from market appreciation.

 

Benefits and Expenses

 

2007 to 2006 Three Month Comparison. Benefits and expenses, as shown in the table above under “—Operating Results,” increased $98 million, from $917 million in the first quarter of 2006 to $1.015 billion in the first quarter of 2007. Interest credited to policyholders’ account balances increased $63 million primarily reflecting higher interest credited on the greater base of guaranteed investment products sold in the institutional and retail markets. Policyholders’ benefits, including the change in policy reserves, increased $33 million and reflect a $21 million increase due to the change in the reinsurance arrangement with respect to the guaranteed cost business acquired from CIGNA discussed above, as well as reserve refinements from updates of client census data on a group annuity block of business and less favorable retirement and mortality experience.

 

Sales Results and Account Values

 

The following table shows the changes in the account values and net additions (withdrawals) of Retirement segment products for the periods indicated. Net additions (withdrawals) are deposits and sales or additions, as applicable, minus withdrawals and benefits. These concepts do not correspond to revenues under U.S. GAAP, but are used as a relevant measure of business activity.

 

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     Three Months Ended
March 31,


 
     2007

    2006

 
     (in millions)  

Full Service(1):

                

Beginning total account value

   $ 97,430     $ 88,385  

Deposits and sales

     4,003       5,381  

Withdrawals and benefits

     (3,433 )     (5,471 )

Change in market value, interest credited and interest income

     1,558       3,559  
    


 


Ending total account value

   $ 99,558     $ 91,854  
    


 


Net additions (withdrawals)

   $ 570     $ (90 )
    


 


Institutional Investment Products(2):

                

Beginning total account value

   $ 50,269     $ 48,080  

Additions

     1,533       1,536  

Withdrawals and benefits

     (1,743 )     (2,452 )

Change in market value, interest credited and interest income

     607       182  

Other(3)

     (5 )     (131 )
    


 


Ending total account value

   $ 50,661     $ 47,215  
    


 


Net additions (withdrawals)

   $ (210 )   $ (916 )
    


 



(1) Ending total account value for the full service business includes assets of Prudential’s retirement plan of $4.6 billion and $5.4 billion as of March 31, 2007 and 2006, respectively.
(2) Ending total account value for the institutional investment products business includes assets of Prudential’s retirement plan of $5.7 billion and $5.3 billion as of March 31, 2007 and 2006, respectively.
(3) Primarily represents changes in asset balances for externally managed accounts.

 

2007 to 2006 Three Month Comparison. Account values in our full service business amounted to $99.6 billion as of March 31, 2007, an increase of $2.1 billion from December 31, 2006. The increase in account values was driven primarily by an increase in the market value of customer funds and interest on general account business, as well as net additions of $570 million. Account values in our full service business increased $7.7 billion from March 31, 2006, primarily reflecting an increase in the market value of customer funds and interest on general account business and, to a lesser extent, net additions. Net additions (withdrawals) improved $660 million, from net withdrawals of $90 million in the first quarter of 2006 to net additions of $570 million in the first quarter of 2007. This improvement reflects lower gross withdrawals, as the first quarter of 2006 included three large plan terminations totaling $2.1 billion primarily associated with merger and plan consolidation activity. This improvement was partially offset by lower gross sales as the first quarter of 2006 reflects a single large client sale totaling $1.6 billion.

 

Account values in our institutional investment products business amounted to $50.7 billion as of March 31, 2007, an increase of $392 million from December 31, 2006, primarily reflecting interest on general account business and an increase in the market value of customer funds. Account values in our institutional investment products business increased $3.4 billion from March 31, 2006, primarily reflecting interest on general account business and an increase in the market value of customer funds and, to a lesser extent, net additions. Net withdrawals improved $706 million from net withdrawals of $916 million in the first quarter of 2006 to net withdrawals of $210 million in the first quarter of 2007. This improvement reflects the impact of a transfer in the first quarter of 2006 of approximately $1.4 billion from the Retirement segment to our Asset Management segment, partially offset by higher scheduled withdrawals of guaranteed investment products in the first quarter of 2007.

 

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International Insurance and Investments Division

 

As a U.S.-based company with significant business operations outside the U.S., we seek to mitigate the risk that future unfavorable foreign currency exchange rate movements will reduce our U.S. dollar equivalent earnings. The operations of our International Insurance and International Investments segments are subject to currency fluctuations that can materially affect their U.S. dollar results from period to period even if results on a local currency basis are relatively constant. As discussed further below, we enter into forward currency derivative contracts, as well as “dual currency” and “synthetic dual currency” investments as part of our strategy to effectively fix the currency exchange rates for a portion of our prospective non-U.S. dollar denominated earnings streams.

 

The financial results of our International Insurance segment and International Investments segment, excluding the global commodities group, for all periods presented reflect the impact of an intercompany arrangement with Corporate and Other operations pursuant to which the segments’ non-U.S. dollar denominated earnings in all countries are translated at fixed currency exchange rates. The fixed rates are determined in connection with a currency hedging program designed to mitigate the risk that unfavorable exchange rate changes will reduce the segments’ U.S. dollar equivalent earnings. Pursuant to this program, Corporate and Other operations executes forward currency contracts with third parties to sell the hedged currency in exchange for U.S. dollars at a specified exchange rate. The maturities of these contracts correspond with the future periods in which the identified non-U.S. dollar denominated earnings are expected to be generated. This program is primarily associated with the International Insurance segment’s businesses in Japan, Korea and Taiwan and the International Investments segment’s businesses in Korea and Europe. The intercompany arrangement with Corporate and Other operations increased (decreased) revenues and adjusted operating income of each segment as follows for the periods indicated:

 

    

Three Months Ended

March 31,


 
         2007    

        2006    

 
     (in millions)  

Impact on revenues and adjusted operating income:

                

International Insurance

   $ 28     $ 12  

International Investments

     (3 )     (2 )
    


 


Total International Insurance and Investments Division

   $ 25     $ 10  
    


 


 

Results of Corporate and Other operations include any differences between the translation adjustments recorded by the segments and the gains or losses recorded from the forward currency contracts. The net effect of this program within the Corporate and Other operations were losses of $4 million for both the three months ended March 31, 2007 and 2006.

 

In addition, our Japanese insurance operations hold dual currency investments in the form of fixed maturities and loans. The principal of these dual currency investments are yen-denominated while the related interest income is U.S. dollar denominated. These investments are the economic equivalent of exchanging what would otherwise be fixed streams of yen-denominated interest income for fixed streams of U.S. dollars. Our Japanese insurance operations also hold investments in yen-denominated investments that have been coupled with cross-currency coupon swap agreements, creating synthetic dual currency investments. The yen/U.S. dollar exchange rate is effectively fixed, as we are obligated in future periods to exchange fixed amounts of Japanese yen interest payments generated by the yen-denominated investments for U.S. dollars at the yen/U.S. dollar exchange rates specified by the cross-currency coupon swap agreements. The effect of these dual currency and synthetic dual currency investments is taken into account as part of our currency hedging program. As of March 31, 2007 and December 31, 2006, the principal of these investments were ¥545 billion, or $4.9 billion, for both periods. For the three months ended March 31, 2007 and 2006, the weighted average yield generated by these investments was 2.3% and 3.2%, respectively. For information regarding the weighted average exchange rate resulting from these investments see “—Dual Currency Investments,” below.

 

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Presented below is the fair value of these instruments as reflected on our balance sheet for the periods presented.

 

     March 31,
2007


   December 31,
2006


     (in millions)

Forward currency contracts

   $ 98    $ 105

Cross-currency coupon swap agreements

     51      54

Foreign exchange component of interest on dual currency investments

     16      11
    

  

Total

   $ 165    $ 170
    

  

 

Our Japanese insurance operations also hold U.S. dollar denominated securities in their investment portfolio, which are discussed in further detail in “—Realized Investment Gains and General Account Investments— General Account Investments.”

 

International Insurance

 

The results of our International Insurance operations are translated on the basis of weighted average monthly exchange rates, inclusive of the effects of the intercompany arrangement discussed above. To provide a better understanding of operating performance within the International Insurance segment, where indicated below, we have analyzed our results of operations excluding the effect of foreign currency fluctuations. Our results of operations excluding the effect of foreign currency fluctuations were derived by translating foreign currencies to U.S. dollars at uniform exchange rates for all periods presented, including Japanese yen at a rate of 102 yen per U.S. dollar; and Korean won at a rate of 1,030 won per U.S. dollar. New annualized premiums presented on a constant exchange rate basis in the “Sales Results” section below reflect translation based on these same uniform exchange rates.

 

Operating Results

 

The following table sets forth the International Insurance segment’s operating results for the periods indicated.

 

     Three Months Ended
March 31,


 
         2007    

        2006    

 
     (in millions)  

Operating Results:

                

Revenues:

                

Life Planner operations

   $ 1,360     $ 1,217  

Gibraltar Life

     694       732  
    


 


       2,054       1,949  
    


 


Benefits and expenses:

                

Life Planner operations

     1,090       989  

Gibraltar Life

     551       622  
    


 


       1,641       1,611  
    


 


Adjusted operating income:

                

Life Planner operations

     270       228  

Gibraltar Life

     143       110  
    


 


       413       338  
    


 


Realized investment gains (losses), net, and related adjustments(1)

     139       26  

Related charges(1)(2)

     (5 )     —    

Investment gains on trading account assets supporting insurance liabilities, net(3)

     22       31  

Change in experience-rated contractholder liabilities due to asset value changes(4)

     (22 )     (31 )

Equity in earnings of operating joint ventures(5)

     —         —    
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 547     $ 364  
    


 


 

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(1) Revenues exclude Realized investment gains (losses), net, and related charges and adjustments. The related charges represent the impact of Realized investment gains (losses), net, on the amortization of unearned revenue reserves. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”
(2) Benefits and expenses exclude related charges that represent the element of “Dividends to policyholders” that is based on a portion of certain realized investment gains required to be paid to policyholders and the impact of Realized investment gains (losses), net, on the amortization of deferred policy acquisition costs.
(3) Revenues exclude net investment gains and losses on trading account assets supporting insurance liabilities. See “—Trading Account Assets Supporting Insurance Liabilities.”
(4) Benefits and expenses exclude changes in contractholder liabilities due to asset value changes in the pool of investments supporting these experience-rated contracts. See “—Trading Account Assets Supporting Insurance Liabilities.”
(5) Equity in earnings of operating joint ventures are included in adjusted operating income but excluded from income from continuing operations before income taxes and equity in earnings of operating joint ventures as they are reflected on a U.S. GAAP basis on an after-tax basis as a separate line in our Unaudited Interim Consolidated Statements of Operations.

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income from Life Planner operations increased $42 million, from $228 million in the first quarter of 2006 to $270 million in first quarter of 2007, including a $9 million favorable impact of currency fluctuations. Excluding the impact of currency fluctuations, adjusted operating income of our Life Planner operations increased $33 million, reflecting continued growth of our Japanese and Korean Life Planner operations and improved investment income margins. The improved investment income margins are primarily the result of increased U.S. dollar based investments and duration lengthening in the portfolio.

 

Gibraltar Life’s adjusted operating income increased $33 million, from $110 million in the first quarter of 2006 to $143 million in the first quarter of 2007, including a $1 million favorable impact of currency fluctuations. Excluding the impact of currency fluctuations, adjusted operating income of Gibraltar Life increased $32 million reflecting improved investment income margins and more favorable mortality experience and expense levels. The improvement in investment income margins was primarily a result of lengthening portfolio durations, increased U.S. dollar based investments and continued growth of our U.S. dollar denominated annuity product.

 

Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $105 million, from $1.949 billion in the first quarter of 2006 to $2.054 billion in the first quarter of 2007, including a net favorable impact of $9 million relating to currency fluctuations. Excluding the impact of currency fluctuations, revenues increased $96 million, from $2.143 billion in the first quarter of 2006 to $2.239 billion in the first quarter of 2007.

 

Revenues from our Life Planner operations increased $143 million, from $1.217 billion in the first quarter of 2006 to $1.360 billion in the first quarter of 2007, including a net unfavorable impact of currency fluctuations of $3 million. Excluding the impact of currency fluctuations, revenues increased $146 million from the first quarter of 2006 to the first quarter of 2007. This increase in revenues came primarily from increases in premiums and policy charges and fee income of $108 million, from $1.143 billion in the first quarter of 2006 to $1.251 billion in the first quarter of 2007, and an increase in net investment income of $33 million, from $170 million in the first quarter of 2006 to $203 million in the first quarter of 2007, reflecting asset growth and higher yields primarily due to increased U.S. dollar based investments and duration lengthening in the portfolio. Premiums and policy charges and fee income from our Japanese Life Planner operation increased $81 million, from $839

 

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million in the first quarter of 2006 to $920 million in the first quarter of 2007. Premiums and policy charges and fee income from our Korean operation increased $19 million, from $241 million in the first quarter of 2006 to $260 million in the first quarter of 2007. The increase in premiums and policy charges and fee income in both operations was primarily the result of new sales and strong persistency.

 

Revenues from Gibraltar Life declined $38 million, from $732 million in the first quarter of 2006 to $694 million in the first quarter of 2007, including a favorable impact from currency fluctuations of $12 million. Excluding the impact of currency fluctuations, revenues for Gibraltar Life declined $50 million, from $833 million in the first quarter of 2006 to $783 million in the first quarter of 2007 reflecting a decline in premiums of $82 million, from $628 million in the first quarter of 2006 to $546 million in the first quarter of 2007, partially offset by a $27 million increase in net investment income, from $191 million in the first quarter of 2006 to $218 million in the first quarter of 2007. Premiums in the first quarter of 2006 benefited $71 million from additional face amounts of insurance issued pursuant to a special dividend arrangement established as part of Gibraltar Life’s reorganization for which the first quarter of 2007 included no such benefit. Substantially all of these premiums recognized pursuant to the special dividend arrangement were offset by a corresponding charge to increase reserves for the affected policies. Excluding the impact of the special dividend arrangement, premiums declined $11 million reflecting the expected attrition of older business. Our premiums have declined as the market has continued to transition from traditional products, on which we record premiums, to products with a retirement and savings objective, for which customer funds received are recorded as deposits. The increase in net investment income reflects higher portfolio yields from duration lengthening, increased U.S. dollar based investments and continued growth of our U.S. dollar denominated annuity product.

 

Benefits and Expenses

 

2007 to 2006 Three Month Comparison. Benefits and expenses, as shown in the table above under “—Operating Results,” increased $30 million, from $1.611 billion in the first quarter of 2006 to $1.641 billion in the first quarter of 2007, including a net favorable impact of $1 million related to currency fluctuations. Excluding the impact of currency fluctuations, benefits and expenses increased $31 million, from $1.797 billion in the first quarter of 2006 to $1.828 billion in the first quarter of 2007.

 

Benefits and expenses of our Life Planner operations increased $101 million, from $989 million in the first quarter of 2006 to $1.090 billion in the first quarter of 2007, including the net favorable impact of $12 million from currency fluctuations. Excluding the impact of currency fluctuations, benefits and expenses increased $113 million, from $1.077 billion in the first quarter of 2006 to $1.190 billion in the first quarter of 2007. Benefits and expenses of our Japanese Life Planner operation increased $84 million, from $763 million in the first quarter of 2006 to $847 million in the first quarter of 2007. Benefits and expenses from our Korean operation increased $17 million, from $223 million in the first quarter of 2006 to $240 million in first quarter of 2007. The increase in benefits and expenses in both operations reflects an increase in changes in reserves, which was driven by new sales and strong persistency.

 

Gibraltar Life’s benefits and expenses declined $71 million, from $622 million in the first quarter of 2006 to $551 million in the first quarter of 2007, including a $11 million unfavorable impact of currency fluctuations. Excluding the impact of the currency fluctuations, benefits and expenses declined $82 million, from $720 million in the first quarter of 2006 to $638 million in the first quarter of 2007, reflecting primarily the effects of special dividend arrangement described above, the expected attrition of older business, and a more favorable level of policyholders’ benefits, partially offset by an increase in interest credited to policyholders’ account balances resulting from growth in our U.S. dollar denominated annuity product.

 

Sales Results

 

In managing our international insurance business, we analyze revenues, as well as new annualized premiums, which do not correspond to revenues under U.S. GAAP. New annualized premiums measure the

 

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current sales performance of the segment, while revenues primarily reflect the renewal persistency of policies written in prior years and net investment income, in addition to current sales. New annualized premiums include 10% of first year premiums or deposits from single pay products. New annualized premiums on an actual and constant exchange rate basis are as follows for the periods indicated.

 

    

Three Months Ended

March 31,


         2007    

       2006    

     (in millions)

New annualized premiums:

             

On an actual exchange rate basis:

             

Life Planner operations

   $ 223    $ 216

Gibraltar Life

     76      73
    

  

Total

   $ 299    $ 289
    

  

On a constant exchange rate basis:

             

Life Planner operations

   $ 235    $ 228

Gibraltar Life

     84      80
    

  

Total

   $ 319    $ 308
    

  

 

2007 to 2006 Three Month Comparison. On a constant exchange rate basis, new annualized premiums increased $11 million, from $308 million in the first quarter of 2006 to $319 million in the first quarter of 2007. On the same basis, new annualized premiums from our Japanese Life Planner operation increased $16 million, reflecting primarily an increase in sales of U.S. dollar denominated products including an increase in sales of our U.S. dollar denominated retirement income product in anticipation of a rate increase relative to the product’s annuitization benefits. Sales in all other operations, also on a constant exchange rate basis, declined $9 million, primarily reflecting declines in sales from our Life Planner operations in Korea and Taiwan. New annualized premiums from our Gibraltar Life operation increased $4 million, on a constant exchange rate basis, from the first quarter of 2006 to the first quarter of 2007. New annualized premiums from our U.S. dollar denominated single premium fixed annuity were essentially unchanged from first quarter 2006 as sales of $7 million in the current quarter from our bank channel, which commenced in March 2006, were offset by declines in sales from our Life Advisors.

 

Investment Margins and Other Profitability Factors

 

Many of our insurance products sold in international markets provide for the buildup of cash values for the policyholder at mandated guaranteed interest rates. Japanese authorities regulate interest rates guaranteed in our Japanese insurance contracts. The regulated guaranteed interest rates do not necessarily match the actual returns on the underlying investments. The spread between the actual investment returns and these guaranteed rates of return to the policyholder is an element of the profit or loss that we will experience on these products. With regulatory approval, guaranteed rates may be changed on new business. While these actions enhance our ability to set rates commensurate with available investment returns, the major sources of profitability on our products sold in Japan, other than those sold by Gibraltar Life, are margins on mortality, morbidity and expense charges rather than investment spreads.

 

We base premiums and cash values in most countries in which we operate on mandated mortality and morbidity tables. Our mortality and morbidity experience in the International Insurance segment on an overall basis in the first quarter of 2007 and the first quarter of 2006 was well within our pricing assumptions and below the guaranteed levels reflected in the premiums we charge.

 

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Dual Currency Investments

 

The table below presents as of March 31, 2007, the yen-denominated earnings subject to our dual currency and synthetic dual currency investments and the related weighted average exchange rates resulting from these investments.

 

Year


  

(1)

Interest component of
dual currency
investments


   Cross-currency
coupon swap element of
synthetic dual
currency investments


   Yen-denominated
earnings subject to
these investments


   Weighted average
exchange rate per U.S.
Dollar


          (in billions)         (Yen per $)

Remainder of 2007

   ¥ 3.1    ¥ 6.0    ¥ 9.1    90.0

2008

     3.5      6.5      10.0    90.3

2009

     3.4      5.8      9.2    89.1

2010

     3.2      4.9      8.1    87.2

2011-2034

     39.1      60.2      99.2    79.8
    

  

  

    

Total

   ¥ 52.3    ¥ 83.4    ¥ 135.6    82.2
    

  

  

    

(1) Yen amounts are imputed from the contractual U.S. dollar denominated interest cash flows.

 

The table above does not reflect the currency hedging program discussed above. Our Japanese insurance operations also hold U.S. dollar denominated securities in their investment portfolio, which are discussed in further detail in “—Realized Investment Gains and General Account Investments— General Account Investments.”

 

International Investments

 

Operating Results

 

The following table sets forth the International Investments segment’s operating results for the periods indicated.

 

    

Three Months Ended

March 31,


 
         2007    

        2006    

 
     (in millions)  

Operating results:

                

Revenues

   $ 177     $ 150  

Expenses

     115       106  
    


 


Adjusted operating income

     62       44  

Realized investment gains (losses), net, and related adjustments(1)

     —         1  

Related charges(2)

     —         —    

Equity in earnings of operating joint ventures(3)

     (9 )     (9 )
    


 


Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 53     $ 36  
    


 



(1) Revenues exclude Realized investment gains (losses), net, and related adjustments. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”
(2) Benefits and expenses exclude related charges which represent the unfavorable (favorable) impact of Realized investment gains (losses), net, on minority interest.
(3) Equity in earnings of operating joint ventures are included in adjusted operating income but excluded from income from continuing operations before income taxes and equity in earnings of operating joint ventures as they are reflected on a U.S. GAAP basis on an after-tax basis as a separate line in our Unaudited Interim Consolidated Statements of Operations.

 

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In 2004, we acquired an 80 percent interest in Hyundai Investment and Securities Co., Ltd., a Korean asset management firm, from an agency of the Korean government. We subsequently renamed the company Prudential Investment & Securities Co., Ltd, or PISC. On February 28, 2007, we notified the Korean government of our intention to purchase the remaining 20 percent under the terms of the original acquisition agreement.

 

Adjusted Operating Income

 

2007 to 2006 Three Month Comparison. Adjusted operating income increased $18 million, from $44 million in the first quarter of 2006 to $62 million in the first quarter of 2007. The increase came primarily from fees associated with unusually strong current quarter sales in our Korean asset management operation of mutual funds invested in overseas markets that carry a front end load and income from an equity-related investment, together with favorable sales and trading results from the segment’s global commodities group. Reflected in adjusted operating income are market value changes on securities relating to exchange memberships of $11 million and $15 million in the first quarter of 2007 and 2006, respectively. Adjusted operating income from the Korean asset management operations includes $5 million and $6 million in the first quarter of 2007 and 2006, respectively, of fee revenue from the Korean government under an agreement entered into in connection with the acquisition in 2004 of PISC, related to the provision of asset management and brokerage services, which agreement extends until February 27, 2009.

 

Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $27 million, from $150 million in the first quarter of 2006 to $177 million in the first quarter of 2007, primarily as a result of higher commission and fee revenue from our Korean asset management operations.

 

Expenses

 

2007 to 2006 Three Month Comparison. Expenses, as shown in the table above under “—Operating Results,” increased $9 million, from $106 million in the first quarter of 2006 to $115 million in the first quarter of 2007, primarily due to higher operating expenses corresponding with the higher level of revenues generated by our Korean asset management operations.

 

Corporate and Other

 

Corporate and Other includes corporate operations, after allocations to our business segments, and our real estate and relocation services business.

 

Corporate operations consist primarily of: (1) corporate-level income and expenses, after allocations to any of our business segments, including income and expense from our qualified pension and other employee benefit plans and investment returns on capital that is not deployed in any of our segments; (2) returns from investments that we do not allocate to any of our business segments, including a debt-financed investment portfolio, as well as the impact of transactions with other segments; and (3) businesses that we have placed in wind-down status but have not divested.

 

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     Three Months Ended
March 31,


         2007    

        2006    

     (in millions)

Operating Results:

              

Corporate Operations(1)

   $ 15     $ 16

Real Estate and Relocation Services

     (3 )     10
    


 

Adjusted operating income

     12       26

Realized investment gains (losses), net, and related adjustments(2)

     18       42

Investment gains on trading account assets supporting insurance liabilities(1)(3)

     2       —  

Divested businesses(4)

     19       13
    


 

Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 51     $ 81
    


 


(1) Includes consolidating adjustments.
(2) Revenues exclude Realized investment gains (losses), net, and related adjustments. See “—Realized Investment Gains and General Account Investments—Realized Investment Gains.”
(3) Revenues exclude net investment gains and losses on trading account assets supporting insurance liabilities. See “—Trading Account Assets Supporting Insurance Liabilities.”
(4) See “—Divested Businesses.”

 

2007 to 2006 Three Month Comparison. Adjusted operating income decreased $14 million, from $26 million in the first quarter of 2006 to $12 million in the first quarter of 2007. Adjusted operating income from corporate operations was essentially unchanged. Corporate operations investment income, net of interest expense and interest credited to policyholders’ account balances decreased, primarily reflecting the impact of deployment of our excess capital in our businesses and for share repurchases, increased borrowings and less favorable income from equity method investments. These items were partially offset by income from the investment of proceeds from our December 2006 convertible debt issuance of $2 billion principal amount. Investment income, net of interest expense, includes approximately $13 million in both the first quarter of 2007 and first quarter of 2006 related to investment of proceeds of a $2 billion issue of convertible debt securities in November 2005 that the company has called for redemption in May 2007.

 

Corporate operations includes income from our qualified pension plan of $91 million in the first quarter of 2007, an increase of $5 million from $86 million in the first quarter of 2006. The increase reflects changes in the market value of our plan assets.

 

Adjusted operating income of our real estate and relocation services business decreased $13 million, from $10 million in the first quarter of 2006 to a loss of $3 million in the first quarter of 2007. The decline was driven by less favorable residential real estate market conditions in the current quarter.

 

Results of Operations of Closed Block Business

 

We established the Closed Block Business effective as of the date of demutualization. The Closed Block Business includes our in force traditional domestic participating life insurance and annuity products and assets that are used for the payment of benefits and policyholder dividends on these policies, as well as other assets and equity and related liabilities that support these policies. We no longer offer these traditional domestic participating policies. See “—Overview—Closed Block Business” for additional details.

 

At the end of each year, the Board of Directors of Prudential Insurance determines the dividends payable on participating policies for the following year based on the experience of the Closed Block, including investment income, net realized and unrealized investment gains, mortality experience and other factors. Although Closed

 

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Block experience for dividend action decisions is based upon statutory results, at the time the Closed Block was established, we developed, as required by U.S. GAAP, an actuarial calculation of the timing of the maximum future earnings from the policies included in the Closed Block. If actual cumulative earnings in any given period are greater than the cumulative earnings we expected, we will record this excess as a policyholder dividend obligation. We will subsequently pay this excess to Closed Block policyholders as an additional dividend unless it is otherwise offset by future Closed Block performance that is less favorable than we originally expected. The policyholder dividends we charge to expense within the Closed Block Business will include any change in policyholder dividend obligations that we recognize for the excess of actual cumulative earnings in any given period over the cumulative earnings we expected in addition to the actual policyholder dividends declared by the Board of Directors of Prudential Insurance.

 

As of March 31, 2007, the Company has recognized a policyholder dividend obligation to Closed Block policyholders for the excess of actual cumulative earnings over the expected cumulative earnings of $570 million. Actual cumulative earnings, as required by U.S. GAAP, reflect the recognition of realized investment gains in the current period, as well as changes in assets and related liabilities that support the policies. Additionally, net unrealized investment gains have arisen subsequent to the establishment of the Closed Block due to the impact of lower interest rates on the market value of fixed maturities available for sale. These net unrealized investment gains have been reflected as a policyholder dividend obligation of $1.747 billion, as of March 31, 2007, to be paid to Closed Block policyholders, unless otherwise offset by future experience, with an offsetting amount reported in accumulated other comprehensive income.

 

Operating Results

 

Management does not consider adjusted operating income to assess the operating performance of the Closed Block Business. Consequently, results of the Closed Block Business for all periods are presented only in accordance with U.S. GAAP. The following table sets forth the Closed Block Business U.S. GAAP results for the periods indicated.

 

    

Three Months Ended

March 31,


     2007

   2006

     (in millions)

U.S. GAAP results:

             

Revenues

   $ 1,991    $ 1,851

Benefits and expenses

     1,854      1,767
    

  

Income from continuing operations before income taxes and equity in earnings of operating joint ventures

   $ 137    $ 84
    

  

 

Income from Continuing Operations Before Income Taxes and Equity in Earnings of Operating Joint Ventures

 

2007 to 2006 Three Month Comparison. Income from continuing operations before income taxes and equity in earnings of operating joint ventures increased $53 million, from $84 million in the first quarter of 2006 to $137 million in the first quarter of 2007. First quarter 2007 results reflect realized investment gains of $207 million as compared to $60 million in the prior year quarter, an increase of $147 million. For a discussion of Closed Block Business realized investment gains (losses), net, see “—Realized Investment Gains and General Account Investments—Realized Investment Gains.” The increase in net realized investment gains was partially offset by an increase in dividends to policyholders of $80 million, which is comprised primarily of an increase in the policyholder dividend obligation expense of $73 million.

 

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Revenues

 

2007 to 2006 Three Month Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $140 million, from $1.851 billion in the first quarter of 2006 to $1.991 billion in the first quarter of 2007, principally driven by the $147 million increase in net realized investment gains.

 

Benefits and Expenses

 

2007 to 2006 Three Month Comparison. Benefits and expenses, as shown in the table above under “—Operating Results,” increased $87 million, from $1.767 billion in the first quarter of 2006 to $1.854 billion in the first quarter of 2007, as dividends to policyholders increased $80 million reflecting an increase in the policyholder dividend obligation expense of $73 million.

 

Income Taxes

 

Our income tax provision amounted to $424 million in the first three months of 2007 compared to $279 million in the first three months of 2006, representing 30% and 29% of income from continuing operations before income taxes and equity in earnings of operating joint ventures in the first quarter of 2007 and 2006, respectively.

 

We employ various tax strategies, including strategies to minimize the amount of taxes resulting from realized capital gains.

 

We adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an Interpretation of FASB Statement No. 109 on January 1, 2007. For additional information regarding the adoption of this guidance, see Note 2 of the Unaudited Interim Consolidated Financial Statements.

 

Discontinued Operations

 

Included within net income are the results of businesses which are reflected as discontinued operations under U.S. GAAP. A summary of the results of discontinued operations by business is as follows for the periods indicated:

 

     Three Months Ended
March 31,


 
     2007

     2006

 
     (in millions)  

Real estate investments sold or held for sale

   $ 18      $ —    

Canadian intermediate weekly premium and individual health operations

     —          (4 )

Healthcare operations

     5        —    

Other

     (3 )      (4 )
    


  


Income (loss) from discontinued operations before income taxes

     20        (8 )

Income tax expense (benefit)

     (18 )      (2 )
    


  


Income (loss) from discontinued operations, net of taxes

   $ 38      $ (6 )
    


  


 

The three months ended March 31, 2007 includes a $26 million tax benefit associated with a discontinued international business.

 

For additional information regarding discontinued operations, see Note 3 of the Unaudited Interim Consolidated Financial Statements.

 

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Realized Investment Gains and General Account Investments

 

Realized Investment Gains

 

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 other than temporary impairments. Realized investment gains and losses are also generated from prepayment premiums received on private fixed maturity securities, recoveries of principal on previously impaired securities, provisions for losses on commercial loans, fair value changes on commercial mortgage operations’ loans, gains on commercial loans in connection with securitization transactions, fair value changes on embedded derivatives and derivatives that do not qualify for hedge accounting treatment, except those derivatives used in our capacity as a broker or dealer.

 

We perform impairment reviews on an ongoing basis to determine when a decline in value is other than temporary. In evaluating whether a decline in value is other than temporary, we consider several factors including, but not limited to, the following: the extent (generally if greater than 20%) and duration (generally if greater than six months) of the decline in value; the reasons for the decline (credit event, currency or interest-rate related); our ability and intent to hold our investment for a period of time to allow for a recovery of value; and the financial condition of and near-term prospects of the issuer. When we determine that there is an other than temporary impairment, we write down the value of the security to its fair value, with a corresponding charge recorded