Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

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

 

For the quarterly period ended September 30, 2010

 

OR

 

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

 

For the Transition Period from             to            

 

Commission File Number 001-16707

 

 

 

Prudential Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

New Jersey   22-3703799

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

 

751 Broad Street

Newark, New Jersey 07102

(973) 802-6000

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

 

 

 

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

 

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

 

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

 

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

 

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

 

As of October 31, 2010, 465 million shares of the registrant’s Common Stock (par value $0.01) were outstanding. In addition, 2 million shares of the registrant’s Class B Stock, for which there is no established public trading market, were outstanding.

 

 

 


Table of Contents

 

TABLE OF CONTENTS

 

               Page
Number
 

PART I

   FINANCIAL INFORMATION   
  

Item 1.

  

Financial Statements:

  
     

Unaudited Interim Consolidated Statements of Financial Position as of September 30, 2010 and December 31, 2009

     1   
     

Unaudited Interim Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009

     2   
     

Unaudited Interim Consolidated Statements of Equity for the nine months ended September 30, 2010 and 2009

     3   
     

Unaudited Interim Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009

     4   
     

Notes to Unaudited Interim Consolidated Financial Statements

     5   
     

Unaudited Interim Supplemental Combining Financial Information:

  
     

Unaudited Interim Supplemental Financial Statements of Financial Position as of September 30, 2010 and December 31, 2009

     98   
     

Unaudited Interim Supplemental Financial Statements of Operations for the three months ended September 30, 2010 and 2009

     99   
     

Unaudited Interim Supplemental Financial Statements of Operations for the nine months ended September 30, 2010 and 2009

     100   
     

Notes to Unaudited Interim Supplemental Combining Financial Information

     101   
   Item 2.   

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

     103   
   Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     262   
   Item 4.   

Controls and Procedures

     263   

PART II

   OTHER INFORMATION   
  

Item 1.

  

Legal Proceedings

     264   
  

Item 1A.

  

Risk Factors

     265   
  

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     290   
  

Item 6.

  

Exhibits

     291   

SIGNATURES

     292   

 

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Forward-Looking Statements

 

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

September 30, 2010 and December 31, 2009 (in millions, except share amounts)

 

    September 30,
2010
    December 31,
2009
 

ASSETS

   

Fixed maturities, available for sale, at fair value (amortized cost: 2010—$184,586; 2009—$174,251)(1)

  $ 197,189     $ 175,225  

Fixed maturities, held to maturity, at amortized cost (fair value: 2010—$5,522; 2009—$5,198)(1)

    5,233       5,120  

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

    17,750       16,020  

Other trading account assets, at fair value

    5,676       3,033  

Equity securities, available for sale, at fair value (cost: 2010—$6,368; 2009-$6,106)

    7,272       6,895  

Commercial mortgage and other loans (includes $418 and $479 measured at fair value under the fair value option at September 30, 2010 and December 31, 2009, respectively)(1)

    31,924       31,384  

Policy loans

    10,544       10,146  

Other long-term investments (includes $244 million and $0 million measured at fair value under the fair value option at September 30, 2010 and December 31, 2009, respectively)(1)

    6,130       5,904  

Short-term investments

    5,677       6,825  
               

Total investments

    287,395       260,552  

Cash and cash equivalents(1)

    11,973       13,164  

Accrued investment income(1)

    2,416       2,322  

Deferred policy acquisition costs

    15,054       14,578  

Other assets(1)

    15,623       15,513  

Separate account assets(1)

    194,463       174,074  
               

Total Assets

  $ 526,924     $ 480,203  
               

LIABILITIES AND EQUITY

   

LIABILITIES

   

Future policy benefits

  $ 133,660     $ 125,707  

Policyholders’ account balances

    105,298       101,666  

Policyholders’ dividends

    4,384       1,254  

Securities sold under agreements to repurchase

    5,934       6,033  

Cash collateral for loaned securities

    2,465       3,163  

Income taxes

    7,058       4,014  

Short-term debt

    2,572       3,122  

Long-term debt (includes $0 and $429 measured at fair value under the fair value option at September 30, 2010 and December 31, 2009, respectively)

    22,337       21,037  

Other liabilities(1)

    14,685       14,404  

Separate account liabilities(1)

    194,463       174,074  
               

Total liabilities

    492,856       454,474  
               

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 15)

   

EQUITY

   

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

    0       0  

Common Stock ($.01 par value; 1,500,000,000 shares authorized; 641,762,159 and 641,762,089 shares issued at September 30, 2010 and December 31, 2009, respectively)

    6       6  

Class B Stock ($.01 par value; 10,000,000 shares authorized; 2,000,000 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively)

    0       0  

Additional paid-in capital

    23,222       23,235  

Common Stock held in treasury, at cost (176,812,357 and 179,650,931 shares at September 30, 2010 and December 31, 2009, respectively)

    (11,205     (11,390

Accumulated other comprehensive income (loss)

    4,729       (443

Retained earnings

    16,794       13,787  
               

Total Prudential Financial, Inc. equity

    33,546       25,195  
               

Noncontrolling interests

    522       534  
               

Total equity

    34,068       25,729  
               

TOTAL LIABILITIES AND EQUITY

  $ 526,924     $ 480,203  
               

 

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

See Notes to Unaudited Interim Consolidated Financial Statements

 

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Operations

Three and Nine Months Ended September 30, 2010 and 2009 (in millions, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009           2010         2009    

REVENUES

        

Premiums

   $ 4,654     $ 4,100     $ 13,500     $ 12,321  

Policy charges and fee income

     761       613       2,436       2,052  

Net investment income

     3,018       2,854       8,806       8,534  

Asset management fees and other income

     1,500       1,420       3,362       3,617  

Realized investment gains (losses), net:

        

Other-than-temporary impairments on fixed maturity securities

     (435     (398     (2,198     (3,497

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

     345       38       1,715       2,033  

Other realized investment gains (losses), net

     119       (84     2,687       (1,113
                                

Total realized investment gains (losses), net

     29       (444     2,204       (2,577
                                

Total revenues

     9,962       8,543       30,308       23,947  
                                

BENEFITS AND EXPENSES

        

Policyholders’ benefits

     4,538       3,925       13,668       12,152  

Interest credited to policyholders’ account balances

     1,174       1,317       3,640       3,585  

Dividends to policyholders’

     512       566       1,547       842  

General and administrative expenses

     1,998       1,887       7,169       6,527  
                                

Total benefits and expenses

     8,222       7,695       26,024       23,106  
                                

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

     1,740       848       4,284       841  
                                

Income tax expense (benefit)

     520       (153     1,306       (318
                                

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

     1,220       1,001       2,978       1,159  

Equity in earnings of operating joint ventures, net of taxes

     14       31       33       30  
                                

INCOME FROM CONTINUING OPERATIONS

     1,234       1,032       3,011       1,189  

Income from discontinued operations, net of taxes

     8       0       6       26  
                                

NET INCOME

     1,242       1,032       3,017       1,215  

Less: Loss attributable to noncontrolling interests

     (2     (50     (1     (44
                                

NET INCOME ATTRIBUTABLE TO PRUDENTIAL FINANCIAL, INC

   $ 1,244     $ 1,082     $ 3,018     $ 1,259  
                                

EARNINGS PER SHARE (See Note 8)

        

Financial Services Businesses

        

Basic:

        

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

   $ 2.48     $ 2.36     $ 5.37     $ 3.68  

Income from discontinued operations, net of taxes

     0.02       0.00       0.01       0.06  
                                

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

   $ 2.50     $ 2.36     $ 5.38     $ 3.74  
                                

Diluted:

        

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

   $ 2.45     $ 2.35     $ 5.30     $ 3.66  

Income from discontinued operations, net of taxes

     0.01       0.00       0.01       0.06  
                                

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

   $ 2.46     $ 2.35     $ 5.31     $ 3.72  
                                

Closed Block Business

        

Basic and Diluted:

        

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

   $ 33.50     $ (10.00   $ 243.50     $ (199.00

Income from discontinued operations, net of taxes

     0.50       0.00       0.50       0.00  
                                

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

   $ 34.00     $ (10.00   $ 244.00     $ (199.00
                                

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Equity(1)

Nine Months Ended September 30, 2010 and 2009 (in millions)

 

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

Balance December 31, 2009

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

Contributions from noncontrolling interests

                6       6  

Distributions to noncontrolling interests

                (19     (19

Consolidations/deconsolidations of noncontrolling interests

      (2           (2     (1     (3

Stock-based compensation programs

      (11     (11     185         163         163  

Comprehensive income:

               

Net income

        3,018           3,018       (1     3,017  

Other comprehensive income, net of tax

            5,172       5,172       3       5,175  
                                 

Total comprehensive income

              8,190       2       8,192  
                                                               

Balance, September 30, 2010

  $ 6     $ 23,222     $ 16,794     $ (11,205   $ 4,729     $ 33,546     $ 522     $ 34,068  
                                                               
    Prudential Financial, Inc. Equity     Noncontrolling
Interests
    Total
Equity
 
    Common
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Common
Stock
Held In
Treasury
    Accumulated
Other
Comprehensive
Income (loss)
    Total
Prudential
Financial, Inc.
Equity
     

Balance, December 31, 2008

  $ 6     $ 22,001     $ 10,426     $ (11,655   $ (7,343   $ 13,435     $ 351     $ 13,786  

Common Stock issued

      1,391             1,391         1,391  

Contributions from noncontrolling interests

                275       275  

Distributions to noncontrolling interests

                (16     (16

Stock-based compensation programs

      (44     (57     213         112         112  

Impact of adoption of guidance for other-than-temporary impairments of debt securities, net of taxes

        659         (659     0         0  

Comprehensive income:

               

Net income

        1,259           1,259       (44     1,215  

Other comprehensive income (loss), net of tax

            8,101       8,101       (17     8,084  
                                 

Total comprehensive income (loss)

              9,360       (61     9,299  
                                                               

Balance, September 30, 2009

  $ 6     $ 23,348     $ 12,287     $ (11,442   $ 99     $ 24,298     $ 549     $ 24,847  
                                                               

 

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

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2010 and 2009 (in millions)

 

     2010     2009  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 3,017     $ 1,215  

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

    

Realized investment (gains) losses, net

     (2,204     2,577  

Policy charges and fee income

     (705     (850

Interest credited to policyholders’ account balances

     3,639       3,585  

Depreciation and amortization

     (56     158  

Gains on trading account assets supporting insurance liabilities, net

     (720     (1,527

Change in:

    

Deferred policy acquisition costs

     (829     (824

Future policy benefits and other insurance liabilities

     3,115       1,867  

Other trading account assets

     (669     170  

Income taxes

     (1,539     (602

Other, net

     1,555       (1,066
                

Cash flows from operating activities

     4,604       4,703  
                

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from the sale/maturity/prepayment of:

    

Fixed maturities, available for sale

     20,703       33,442  

Fixed maturities, held to maturity

     333       281  

Trading account assets supporting insurance liabilities and other trading account assets

     31,169       24,142  

Equity securities, available for sale

     1,898       1,422  

Commercial mortgage and other loans

     3,067       2,810  

Policy loans

     1,263       1,254  

Other long-term investments

     750       866  

Short-term investments

     16,522       21,182  

Payments for the purchase/origination of:

    

Fixed maturities, available for sale

     (27,860     (31,079

Fixed maturities, held to maturity

     (155     (1,077

Trading account assets supporting insurance liabilities and other trading account assets

     (31,592     (25,706

Equity securities, available for sale

     (1,872     (887

Commercial mortgage and other loans

     (3,530     (2,186

Policy loans

     (1,163     (1,174

Other long-term investments

     (641     (866

Short-term investments

     (15,436     (23,611

Other, net

     414       (209
                

Cash flows used in investing activities

     (6,130     (1,396
                

CASH FLOWS FROM FINANCING ACTIVITIES

    

Policyholders’ account deposits

     16,840       18,420  

Policyholders’ account withdrawals

     (16,944     (20,166

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

     (515     (929

Proceeds from the issuance of Common Stock

     0       1,391  

Cash dividends paid on Common Stock

     (42     (39

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

     554       (4,648

Common Stock reissued for exercise of stock options

     78       39  

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

     2,623       5,151  

Repayments of debt (maturities longer than 90 days)

     (2,544     (6,235

Excess tax benefits from share-based payment arrangements

     11       0  

Other, net

     197       569  
                

Cash flows from (used in) financing activities

     258       (6,447
                

Effect of foreign exchange rate changes on cash balances

     77       83  

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (1,191     (3,057

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     13,164       15,028  
                

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 11,973     $ 11,971  
                

NON-CASH TRANSACTIONS DURING THE PERIOD

    

Treasury Stock shares issued for stock-based compensation programs

   $ 70     $ 97  

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements

 

1. BUSINESS AND BASIS OF PRESENTATION

 

Prudential Financial, Inc. (“Prudential Financial”) and its subsidiaries (collectively, “Prudential” or the “Company”) provide a wide range of insurance, investment management, and other financial products and services to both individual and institutional customers throughout the United States and in many other countries. Principal products and services provided include life insurance, annuities, retirement-related services, mutual funds, investment management, and real estate services. The Company has organized its principal operations into the Financial Services Businesses and the Closed Block Business. The Financial Services Businesses operate through three operating divisions: U.S. Retirement Solutions and Investment Management, U.S. Individual Life and Group Insurance, and International Insurance 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 divested businesses, are included in Corporate and Other operations within the Financial Services Businesses. The Closed Block Business, which includes the Closed Block (see Note 6), is managed separately from the Financial Services Businesses. The Closed Block Business was established on the date of demutualization and includes the Company’s in force participating insurance and annuity products and assets that are used for the payment of benefits and policyholders’ dividends on these products, as well as other assets and equity that support these products and related liabilities. In connection with the demutualization, the Company ceased offering these participating products.

 

Basis of Presentation

 

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

 

In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations have been made. All such adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Company’s Audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

Use of Estimates

 

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

 

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

 

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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. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS

 

Investments in Debt and Equity Securities

 

The Company’s investments in debt and equity securities include fixed maturities; trading account assets; equity securities; and short-term investments. The accounting policies related to these are as follows:

 

Fixed maturities are comprised of bonds, notes and redeemable preferred stock. Fixed maturities classified as “available for sale” are carried at fair value. See Note 13 for additional information regarding the determination of fair value. Fixed maturities that the Company has both the positive intent and ability to hold to maturity are carried at amortized cost and classified as “held to maturity.” The amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity. Interest income, as well as the related amortization of premium and accretion of discount, is included in “Net investment income” under the effective yield method. For mortgage-backed and asset-backed securities, the effective yield is based on estimated cash flows, including prepayment assumptions based on data from widely accepted third-party data sources or internal estimates. In addition to prepayment assumptions, cash flow estimates vary based on assumptions regarding the underlying collateral, including default rates and changes in value. These assumptions can significantly impact income recognition and the amount of other-than-temporary impairments recognized in earnings and other comprehensive income. For high credit quality mortgage-backed and asset-backed securities (those rated AA or above), cash flows are provided quarterly, and the amortized cost and effective yield of the security are adjusted as necessary to reflect historical prepayment experience and changes in estimated future prepayments. The adjustments to amortized cost are recorded as a charge or credit to net investment income in accordance with the retrospective method. For asset-backed and mortgage-backed securities rated below AA, the effective yield is adjusted prospectively for any changes in estimated cash flows. See the discussion below on realized investment gains and losses for a description of the accounting for impairments, as well as the impact of the Company’s adoption on January 1, 2009 of new authoritative guidance for the recognition and presentation of other-than-temporary impairments for debt securities. Unrealized gains and losses on fixed maturities classified as “available for sale,” net of tax, and the effect on deferred policy acquisition costs, valuation of business acquired, deferred sales inducements, future policy benefits and policyholders’ dividends that would result from the realization of unrealized gains and losses, are included in “Accumulated other comprehensive income (loss).”

 

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

 

“Other trading account assets, at fair value” consist primarily of investments and certain derivatives, including those used by the Company in its capacity as a broker-dealer and derivative hedging positions used in a non-broker or non-dealer capacity primarily to economically hedge the risks related to certain products. These instruments are carried at fair value. Realized and unrealized gains and losses on these investments and on derivatives used by the Company in its capacity as a broker-dealer are reported in “Asset management fees and other income.” Interest and dividend income from these investments is reported in “Net investment income.”

 

Equity securities available for sale are comprised of common stock, mutual fund shares, non-redeemable preferred stock, and perpetual preferred stock, and are carried at fair value. The associated unrealized gains and

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

losses, net of tax, and the effect on deferred policy acquisition costs, valuation of business acquired, deferred sales inducements, future policy benefits and policyholders’ dividends that would result from the realization of unrealized gains and losses, are included in “Accumulated other comprehensive income (loss).” The cost of equity securities is written down to fair value when a decline in value is considered to be other-than-temporary. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. Dividends from these investments are recognized in “Net investment income” when declared.

 

Short-term investments primarily consist of highly liquid debt instruments with a maturity of greater than three months and less than twelve months when purchased, other than those debt instruments meeting this definition that are included in “Trading account assets supporting insurance liabilities, at fair value.” These investments are generally carried at fair value and include certain money market investments, short-term debt securities issued by government sponsored entities and other highly liquid debt instruments. Short-term investments held in our broker-dealer operations are marked-to-market through “Asset management fees and other income.”

 

Realized investment gains (losses) are computed using the specific identification method with the exception of some of the Company’s International Insurance businesses’ portfolios, where the average cost method is used. Realized investment gains and losses are generated from numerous sources, including the sale of fixed maturity securities, equity securities, investments in joint ventures and limited partnerships and other types of investments, as well as adjustments to the cost basis of investments for net other-than-temporary impairments recognized in earnings. Realized investment gains and losses are also generated from prepayment premiums received on private fixed maturity securities, recoveries of principal on previously impaired securities, provisions for losses on commercial mortgage and other loans, fair value changes on commercial mortgage loans carried at fair value, and fair value changes on embedded derivatives and free-standing derivatives that do not qualify for hedge accounting treatment, except those derivatives used in the Company’s capacity as a broker or dealer.

 

The Company’s available for sale and held to maturity securities with unrealized losses are reviewed quarterly to identify other-than-temporary impairments in value. In evaluating whether a decline in value is other-than-temporary, the Company considers several factors including, but not limited to the following: (1) the extent and the duration of the decline; (2) the reasons for the decline in value (credit event, currency or interest-rate related, including general credit spread widening); and (3) the financial condition of and near-term prospects of the issuer. With regard to available-for-sale equity securities, the Company also considers the ability and intent to hold the investment for a period of time to allow for a recovery of value. When it is determined that a decline in value of an equity security is other-than-temporary, the carrying value of the equity security is reduced to its fair value, with a corresponding charge to earnings.

 

In addition, in April 2009, the Financial Accounting Standards Board (“FASB”) revised the authoritative guidance for the recognition and presentation of other-than-temporary impairments for debt securities. The Company early adopted this guidance on January 1, 2009. Prior to the adoption of this guidance the Company was required to record an other-than-temporary impairment for a debt security unless it could assert that it had both the intent and ability to hold the security for a period of time sufficient to allow for a recovery in its fair value to its amortized cost basis. The revised guidance indicates that an other-than-temporary impairment must be recognized in earnings for a debt security in an unrealized loss position when an entity either (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery. For all debt securities in unrealized loss positions that do not meet either of these two criteria, the guidance requires that the Company analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the debt security prior to impairment. The Company may use the estimated fair value of collateral as a proxy for

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

the net present value if it believes that the security is dependent on the liquidation of collateral for recovery of its investment. If the net present value is less than the amortized cost of the investment, an other-than-temporary impairment is recognized. In addition to the above mentioned circumstances, the Company also recognizes an other-than-temporary impairment in earnings when a foreign currency denominated security in an unrealized loss position approaches maturity.

 

Under the authoritative guidance for the recognition and presentation of other-than-temporary impairments, when an other-than-temporary impairment of a debt security has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the debt security meets either of these two criteria, the other-than-temporary impairment recognized in earnings is equal to the entire difference between the security’s amortized cost basis and its fair value at the impairment measurement date. For other-than-temporary impairments of debt securities that do not meet these two criteria, the net amount recognized in earnings is equal to the difference between the amortized cost of the debt security and its net present value calculated as described above. Any difference between the fair value and the net present value of the debt security at the impairment measurement date is recorded in “Other comprehensive income (loss).” Unrealized gains or losses on securities for which an other-than-temporary impairment has been recognized in earnings is tracked as a separate component of “Accumulated other comprehensive income (loss).” Prior to the adoption of this guidance in 2009, an other-than-temporary impairment recognized in earnings for debt securities was equal to the total difference between amortized cost and fair value at the time of impairment.

 

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

 

The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods, including increases in cash flow on a prospective basis.

 

Derivative Financial Instruments

 

Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the values of securities or commodities. Derivative financial instruments generally used by the Company include swaps, futures, forwards and options and may be exchange-traded or contracted in the over-the-counter market. Derivative positions are carried at fair value, generally by obtaining quoted market prices or through the use of valuation models. Values can be affected by changes in interest rates, foreign

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

exchange rates, financial indices, values of securities or commodities, credit spreads, market volatility, expected returns and liquidity. Values can also be affected by changes in estimates and assumptions, including those related to counterparty behavior and non-performance risk used in valuation models.

 

Derivatives are used in a non-dealer or broker capacity in insurance, investment and international businesses as well as treasury operations to manage the characteristics of the Company’s asset/liability mix, to manage the interest rate and currency characteristics of assets or liabilities and to mitigate the risk of a diminution, upon translation to U.S. dollars, of expected non-U.S. earnings and net investments in foreign operations resulting from unfavorable changes in currency exchange rates. Additionally, derivatives may be used to seek to reduce exposure to interest rate, credit, foreign currency and equity risks associated with assets held or expected to be purchased or sold, and liabilities incurred or expected to be incurred. As discussed in detail below and in Note 14, all realized and unrealized changes in fair value of non-dealer or broker related derivatives, with the exception of the effective portion of cash flow hedges and effective hedges of net investments in foreign operations, are recorded in current earnings. Cash flows from these derivatives are reported in the operating, investing, or financing activities sections in the Unaudited Interim Consolidated Statements of Cash Flows.

 

Derivatives are also used in a derivative dealer or broker capacity in the Company’s global commodities group to meet the needs of clients by structuring transactions that allow clients to manage their exposure to interest rates, foreign exchange rates, indices or prices of securities and commodities. Realized and unrealized changes in fair value of derivatives used in these dealer related operations are included in “Asset management fees and other income” in the periods in which the changes occur. Cash flows from such derivatives are reported in the operating activities section of the Unaudited Interim Consolidated Statements of Cash Flows.

 

Derivatives are recorded either as assets, within “Other trading account assets, at fair value” or “Other long-term investments,” or as liabilities, within “Other liabilities,” except for embedded derivatives which are recorded with the associated host contract. The Company nets the fair value of all derivative financial instruments with counterparties for which a master netting arrangement has been executed.

 

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

 

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

 

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

 

When a derivative is designated as a fair value hedge and is determined to be highly effective, changes in its fair value, along with changes in the fair value of the hedged asset or liability (including losses or gains on firm

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

commitments), are reported on a net basis in the income statement, generally in “Realized investment gains (losses), net.” When swaps are used in hedge accounting relationships, periodic settlements are recorded in the same income statement line as the related settlements of the hedged items.

 

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

 

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

 

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

 

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

 

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

 

The Company is a party to financial instruments that contain derivative instruments that are “embedded” in the financial instruments. At inception, the Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e., the host contract) and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and changes in its fair value are included in “Realized investment gains (losses), net.” For certain financial

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

instruments that contain an embedded derivative that otherwise would need to be bifurcated and reported at fair value, the Company may elect to classify the entire instrument as a trading account asset and report it within “Other trading account assets, at fair value.”

 

Adoption of New Accounting Pronouncements

 

In March 2010, the FASB issued updated guidance that amends and clarifies the accounting for credit derivatives embedded in interests in securitized financial assets. This new guidance eliminates the scope exception for embedded credit derivatives (except for those that are created solely by subordination) and provides new guidance on how the evaluation of embedded credit derivatives is to be performed. This new guidance is effective for the first interim reporting period beginning after June 15, 2010. The Company’s adoption of this guidance effective with the interim reporting period ending September 30, 2010 did not have a material effect on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

In January 2010, the FASB issued updated guidance that requires new fair value disclosures about significant transfers between Level 1 and 2 measurement categories and separate presentation of purchases, sales, issuances, and settlements within the roll forward of Level 3 activity. Also, this updated fair value guidance clarifies the disclosure requirements about level of disaggregation and valuation techniques and inputs. This new guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of Level 3 activity, which are effective for interim and annual reporting periods beginning after December 15, 2010. The Company adopted the effective portions of this guidance on January 1, 2010. The required disclosures are provided in Note 13. The Company will provide the required disclosures about purchases, sales, issuances, and settlements in the roll forward of Level 3 activity in the interim reporting period ending March 31, 2011.

 

In June 2009, the FASB issued authoritative guidance which changes the analysis required to determine whether or not an entity is a variable interest entity (“VIE”). In addition, the guidance changes the determination of the primary beneficiary of a VIE from a quantitative to a qualitative model. Under the new qualitative model, the primary beneficiary must have both the ability to direct the activities of the VIE and the obligation to absorb either losses or gains that could be significant to the VIE. This guidance also changes when reassessment is needed, as well as requires enhanced disclosures, including the effects of a company’s involvement with a VIE on its financial statements. This guidance is effective for interim and annual reporting periods beginning after November 15, 2009. In February 2010, the FASB issued updated guidance which defers, except for disclosure requirements, the impact of this guidance for entities that (1) possess the attributes of an investment company, (2) do not require the reporting entity to fund losses, and (3) are not financing vehicles or entities that were formerly classified as qualified special purpose entities (“QSPE’s”). The Company’s adoption of this guidance effective January 1, 2010 did not have a material effect on the Company’s consolidated financial position and results of operations. The disclosures required by this revised guidance are provided in Note 5.

 

In June 2009, the FASB issued authoritative guidance which changes the accounting for transfers of financial assets, and is effective for transfers of financial assets occurring in interim and annual reporting periods beginning after November 15, 2009. It removes the concept of a QSPE from the guidance for transfers of financial assets and removes the exception from applying the guidance for consolidation of variable interest entities to qualifying special-purpose entities. It changes the criteria for achieving sale accounting when transferring a financial asset and changes the initial recognition of retained beneficial interests. The guidance also defines “participating interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. The Company’s adoption of this guidance effective January 1, 2010 did not have a material effect on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Future Adoption of New Accounting Pronouncements

 

In October 2010, the FASB issued guidance to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. Under the new guidance acquisition costs are to include only those costs that are directly related to the acquisition or renewal of insurance contracts by applying a model similar to the accounting for loan origination costs. An entity may defer incremental direct costs of contract acquisition that are incurred in transactions with independent third parties or employees as well as the portion of employee compensation costs related to underwriting, policy issuance and processing, medical inspection, and contract selling for successfully negotiated contracts. Additionally, an entity may capitalize as a deferred acquisition cost only those advertising costs meeting the capitalization criteria for direct-response advertising. This change is effective for fiscal years beginning after December 15, 2011 and interim periods within those years. Early adoption as of the beginning of a fiscal year is permitted. The guidance is to be applied prospectively upon the date of adoption, with retrospective application permitted, but not required. The Company will adopt this guidance effective January 1, 2012. The Company is currently assessing the impact of the guidance on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

In July 2010, the FASB issued updated guidance that requires enhanced disclosures related to the allowance for credit losses and the credit quality of a company’s financing receivable portfolio. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The Company will provide the required disclosures in the annual reporting period ending December 31, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after December 15, 2010. The Company will provide these required disclosures in the interim reporting period ending March 31, 2011.

 

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

 

3. ACQUISITIONS AND DISPOSITIONS

 

Agreement to Acquire AIG Star Life Insurance Co., Ltd., AIG Edison Life Insurance Company and Related Entities from AIG

 

On September 30, 2010, Prudential Financial entered into a stock purchase agreement with American International Group, Inc. (“AIG”), pursuant to which Prudential Financial agreed to acquire, directly or through one or more of its subsidiaries, all of the issued and outstanding shares of preferred and common stock of AIG Star Life Insurance Co., Ltd., AIG Edison Life Insurance Company, AIG Financial Assurance Japan K.K., and AIG Edison Service Co., Ltd. for a total purchase price of $4.8 billion. The total purchase price of $4.8 billion is comprised of approximately $4.2 billion in cash and $0.6 billion in assumed third party debt, substantially all of which is expected to be repaid with excess capital of the acquired entities. All acquired entities are Japanese corporations and their businesses are in Japan. The transaction, which is expected to close in the first quarter of 2011, is subject to certain governmental approvals, including Japanese anti-competition approvals (or expirations of waiting periods) and Japanese insurance regulatory approvals, as well as other customary conditions to closing, including the execution and delivery of related transaction documents.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Sale of investment in Wachovia Securities

 

On December 31, 2009, the Company completed the sale of its minority joint venture interest in Wachovia Securities Financial Holdings, LLC (“Wachovia Securities”), which includes Wells Fargo Advisors, to Wells Fargo & Company (“Wells Fargo”). The Company’s minority joint venture interest in Wachovia Securities originated as a result of the Company combining its retail securities brokerage and clearing operations with those of Wachovia Corporation (“Wachovia”) in 2003. On December 31, 2008, Wachovia merged with and into Wells Fargo, which succeeded to Wachovia’s rights and obligations under the joint venture arrangements. At the closing, the Company received $4.5 billion in cash as the purchase price of its joint venture interest and de-recognized the carrying value of its investment in the joint venture and the carrying value of the associated “lookback” option. The pre-tax gain on sale recognized by the Company was $2.247 billion and was reflected in “Equity in earnings of operating joint ventures, net of taxes.”

 

Acquisition of Yamato Life

 

On May 1, 2009, the Company’s Gibraltar Life operations acquired Yamato Life, a Japanese life insurance company that declared bankruptcy in October 2008. Gibraltar Life served as the reorganization sponsor for Yamato and under the reorganization agreement acquired Yamato by contributing $72 million of capital to Yamato. At the date of acquisition the Company recognized $2.3 billion of assets and $2.3 billion of liabilities related to Yamato. Subsequent to the acquisition, the Company renamed the acquired company The Prudential Gibraltar Financial Life Insurance Company, Ltd.

 

Discontinued Operations

 

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

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
       2010          2009         2010         2009    
     (in millions)  

Korean asset management operations

   $ 3      $ 4     $ 35     $ 15  

Equity sales, trading and research operations

     0        1       0       2  

Real estate investments sold or held for sale

     1        (6     5       22  

Mexican asset management operations

     6        0       6       (1

Healthcare operations

     1        0       1       0  

International securities operations

     0        0       (1     1  
                                 

Income (loss) from discontinued operations before income taxes

     11        (1     46       39  

Income tax expense (benefit)

     3        (1     40       13  
                                 

Income from discontinued operations, net of taxes

   $ 8      $ 0     $ 6     $ 26  
                                 

 

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

 

Real estate investments sold or held for sale reflects the income or loss from discontinued real estate investments.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

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

 

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

 

     September 30,
2010
     December 31,
2009
 
     (in millions)  

Total assets

   $ 112      $ 937  

Total liabilities

   $ 62      $ 556  

 

4. INVESTMENTS

 

Fixed Maturities and Equity Securities

 

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

 

     September 30, 2010  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value      Other-than-
temporary
impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, available for sale

  

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

   $ 9,774      $ 1,428      $ 43      $ 11,159      $ 0  

Obligations of U.S. states and their political subdivisions

     1,895        145        3        2,037        0  

Foreign government bonds

     45,544        4,341        20        49,865        0  

Corporate securities

     93,631        9,284        1,935        100,980        (28

Asset-backed securities(1)

     12,379        240        2,124        10,495        (1,679

Commercial mortgage-backed securities

     11,526        858        61        12,323        3  

Residential mortgage-backed securities(2)

     9,837        562        69        10,330        (12
                                            

Total fixed maturities, available for sale

   $ 184,586      $ 16,858      $ 4,255      $ 197,189      $ (1,716
                                            

Equity securities, available for sale

   $ 6,368      $ 1,083      $ 179      $ 7,272     
                                      

 

(1) Includes credit tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, education loans, and other asset types.
(2) Includes publicly traded agency pass-through securities and collateralized mortgage obligations.
(3) Represents the amount of other-than-temporary impairment losses in “Accumulated other comprehensive income (loss),” or “AOCI,” which were not included in earnings. Amount excludes $542 million of net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

     September 30, 2010  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value      Other-than-
temporary
impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, held to maturity

  

Foreign government bonds

   $ 1,164      $ 120      $ 0      $ 1,284      $ 0  

Corporate securities

     1,011        8        94        925        0  

Asset-backed securities(1)

     1,185        62        0        1,247        0  

Commercial mortgage-backed securities

     474        116        0        590        0  

Residential mortgage-backed securities(2)

     1,399        77        0        1,476        0  
                                            

Total fixed maturities, held to maturity

   $ 5,233      $ 383      $ 94      $ 5,522      $ 0  
                                            

 

(1) Includes credit tranched securities collateralized by auto loans, credit cards, education loans, and other asset types.
(2) Includes publicly traded agency pass-through securities and collateralized mortgage obligations.
(3) Represents the amount of other-than-temporary impairment losses in “Accumulated other comprehensive income (loss),” or “AOCI,” which were not included in earnings.

 

     December 31, 2009  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value      Other-than-
temporary
impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, available for sale

  

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

   $ 8,254      $ 384      $ 370      $ 8,268      $ 0  

Obligations of U.S. states and their political subdivisions

     1,389        28        42        1,375        0  

Foreign government bonds(4)

     40,627        1,569        142        42,054        0  

Corporate securities(4)

     89,083        4,357        2,739        90,701        (43

Asset-backed securities(1)

     12,587        155        2,504        10,238        (1,716

Commercial mortgage-backed securities

     11,036        202        220        11,018        1  

Residential mortgage-backed securities(2)

     11,275        428        132        11,571        (11
                                            

Total fixed maturities, available for sale

   $ 174,251      $ 7,123      $ 6,149      $ 175,225      $ (1,769
                                            

Equity securities, available for sale

   $ 6,106      $ 1,014      $ 225      $ 6,895     
                                      

 

(1) Includes credit tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, education loans, and other asset types.
(2) Includes publicly traded agency pass-through securities and collateralized mortgage obligations.
(3) Represents the amount of other-than-temporary impairment losses in “Accumulated other comprehensive income (loss),” or “AOCI,” which were not included in earnings. Amount excludes $540 million of net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.
(4) Includes reclassifications to conform to current period presentation.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

     December 31, 2009  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value      Other-than-
temporary
impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, held to maturity

  

Foreign government bonds

   $ 1,058      $ 25      $ 1      $ 1,082      $ 0  

Corporate securities

     876        1        126        751        0  

Asset-backed securities(1)

     1,112        16        3        1,125        0  

Commercial mortgage-backed securities

     460        104        0        564        0  

Residential mortgage-backed securities(2)

     1,614        65        3        1,676        0  
                                            

Total fixed maturities, held to maturity

   $ 5,120      $ 211      $ 133      $ 5,198      $ 0  
                                            

 

(1) Includes credit tranched securities collateralized by auto loans, credit cards, education loans, and other asset types.
(2) Includes publicly traded agency pass-through securities and collateralized mortgage obligations.
(3) Represents the amount of other-than-temporary impairment losses in “Accumulated other comprehensive income (loss),” or “AOCI,” which were not included in earnings.

 

The amortized cost and fair value of fixed maturities by contractual maturities at September 30, 2010, are as follows:

 

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

Due in one year or less

   $ 8,477      $ 8,596      $ 0      $ 0  

Due after one year through five years

     36,709        38,431        0        0  

Due after five years through ten years

     37,666        41,136        218        222  

Due after ten years

     67,992        75,878        1,957        1,987  

Asset-backed securities

     12,379        10,495        1,185        1,247  

Commercial mortgage-backed securities

     11,526        12,323        474        590  

Residential mortgage-backed securities

     9,837        10,330        1,399        1,476  
                                   

Total

   $ 184,586      $ 197,189      $ 5,233      $ 5,522  
                                   

 

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

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

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

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009         2010     2009  
     (in millions)  

Fixed maturities, available for sale

        

Proceeds from sales

   $ 2,562     $ 3,354     $ 8,961     $ 19,997  

Proceeds from maturities/repayments

     3,986       4,916       11,762       13,342  

Gross investment gains from sales, prepayments, and maturities

     218       150       485       779  

Gross investment losses from sales and maturities

     (46     (98     (165     (474

Fixed maturities, held to maturity

        

Gross investment gains from prepayments

   $ 0     $ 0     $ 0     $ 0  

Proceeds from maturities/repayments

     108       113       332       281  

Fixed maturity and equity security impairments

        

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

   $ (90   $ (360   $ (483   $ (1,464

Writedowns for impairments on equity securities

     (25     (223     (101     (979

 

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

 

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

 

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

   

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

Balance, beginning of period

   $ 1,775     $ 1,747  

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

     (42     (290

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

     (24     (32

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

     4       134  

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

     26       157  

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

     18       81  

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

     (10     (50
                

Balance, September 30, 2010

   $ 1,747     $ 1,747  
                

 

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

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

     Three Months
Ended
September 30, 2009
    Nine Months
Ended
September  30, 2009
 
     (in millions)  

Balance, beginning of period

   $ 1,522     $ 0  

Credit losses remaining in retained earnings related to adoption of new authoritative guidance on January 1, 2009

     0       658  

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

     (60     (151

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

     (3     (9

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

     81       639  

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

     209       603  

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

     13       29  

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

     (17     (24
                

Balance, September 30, 2009

   $ 1,745     $ 1,745  
                

 

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

 

Trading Account Assets Supporting Insurance Liabilities

 

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

 

     September 30, 2010      December 31, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Short-term investments and cash equivalents

   $ 777      $ 777      $ 725      $ 725  

Fixed maturities:

           

Corporate securities

     9,636        10,449        9,202        9,502  

Commercial mortgage-backed securities

     2,186        2,272        1,899        1,893  

Residential mortgage-backed securities

     1,271        1,294        1,434        1,432  

Asset-backed securities

     1,090        956        1,022        857  

Foreign government bonds

     533        553        508        517  

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

     419        420        169        159  
                                   

Total fixed maturities

     15,135        15,944        14,234        14,360  

Equity securities

     1,144        1,029        1,033        935  
                                   

Total trading account assets supporting insurance liabilities

   $ 17,056      $ 17,750      $ 15,992      $ 16,020  
                                   

 

The net change in unrealized gains (losses) from trading account assets supporting insurance liabilities still held at period end, recorded within “Asset management fees and other income” was $363 million and $692 million during the three months ended September 30, 2010 and 2009, respectively, and $666 million and $1,689 million during the nine months ended September 30, 2010 and 2009, respectively.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Other Trading Account Assets

 

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

 

     September 30, 2010      December 31, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Short-term investments and cash equivalents

   $ 5      $ 5      $ 5      $ 5  

Fixed Maturities:

           

Asset-backed securities

     749        698        1,043        991  

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

     354        357        90        95  

Residential mortgage-backed securities

     311        186        287        158  

Corporate securities

     315        321        345        359  

Commercial mortgage-backed securities

     152        102        239        136  

Foreign government bonds

     25        26        23        24  
                                   

Total fixed maturities

     1,906        1,690        2,027        1,763  

Other(1)

     26        30        25        29  

Equity securities

     470        484        456        471  
                                   

Subtotal

   $ 2,407      $ 2,209      $ 2,513      $ 2,268  
                                   

Derivative instruments

        3,467           765  
                                   

Total other trading account assets

   $ 2,407      $ 5,676      $ 2,513      $ 3,033  
                                   

 

(1) Includes reclassifications to conform to current period presentation.

 

The net change in unrealized gains (losses) from other trading account assets, excluding derivative instruments, still held at period end, recorded within “Asset management fees and other income” was $73 million and $32 million during the three months ended September 30, 2010 and 2009, respectively, and $47 million and $80 million during the nine months ended September 30, 2010 and 2009, respectively.

 

Concentrations of Financial Instruments

 

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

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

As of September 30, 2010 and December 31, 2009, the Company was not exposed to any concentrations of credit risk of any single issuer greater than 10% of the Company’s stockholders’ equity, other than securities of the U.S. government, certain U.S. government agencies and certain securities guaranteed by the U.S. government, as well as the securities disclosed below.

 

     September 30, 2010      December 31, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in Japanese government and government agency securities:

  

Fixed maturities, available for sale

   $ 37,307      $ 40,610      $ 33,393      $ 34,449  

Fixed maturities, held to maturity

     1,164        1,284        1,058        1,082  

Trading account assets supporting insurance liabilities

     406        421        361        368  

Other trading account assets

     16        16        22        23  

Short-term investments

     0        0        0        0  

Cash equivalents

     0        0        0        0  
                                   

Total

   $ 38,893      $ 42,331      $ 34,834      $ 35,922  
                                   
     September 30, 2010      December 31, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in South Korean government and government agency securities:

           

Fixed maturities, available for sale

   $ 3,790      $ 4,186      $ 3,284      $ 3,280  

Fixed maturities, held to maturity

     0        0        0        0  

Trading account assets supporting insurance liabilities

     17        18        17        18  

Other trading account assets

     2        2        1        1  

Short-term investments

     0        0        0        0  

Cash equivalents

     0        0        0        0  
                                   

Total

   $ 3,809      $ 4,206      $ 3,302      $ 3,299  
                                   
     September 30, 2010      December 31, 2009  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in Federal Home Loan Mortgage Corporation (FHLMC) securities:

           

Fixed maturities, available for sale

   $ 379      $ 383      $ 148      $ 158  

Fixed maturities, held to maturity

     0        0        0        0  

Trading account assets supporting insurance liabilities

     165        165        161        161  

Other trading account assets

     0        0        0        0  

Short-term investments

     881        881        1,333        1,333  

Cash equivalents

     1,931        1,931        328        328  
                                   

Total

   $ 3,356      $ 3,360      $ 1,970      $ 1,980  
                                   

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Net Investment Income

 

Net investment income for the three and nine months ended September 30, 2010 and 2009 was from the following sources:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      
     (in millions)  

Fixed maturities, available for sale

   $ 2,109     $ 2,014     $ 6,229     $ 6,115  

Fixed maturities, held to maturity

     32       37       100       105  

Equity securities, available for sale

     71       80       219       235  

Trading account assets

     218       203       615       613  

Commercial mortgage and other loans

     487       480       1,404       1,448  

Policy loans

     146       144       429       422  

Broker-dealer related receivables

     4       4       10       15  

Short-term investments and cash equivalents

     14       22       37       113  

Other long-term investments

     38       (15     66       (174
                                

Gross investment income

     3,119       2,969       9,109       8,892  

Less: investment expenses

     (101     (115     (303     (358
                                

Net investment income

   $ 3,018     $ 2,854     $ 8,806     $ 8,534  
                                

 

Realized Investment Gains (Losses), Net

 

Realized investment gains (losses), net, for the three and nine months ended September 30, 2010 and 2009 were from the following sources:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      
     (in millions)  

Fixed maturities

   $ 82     $ (308   $ (163   $ (1,159

Equity securities

     29       (123     128       (942

Commercial mortgage and other loans

     44       (124     51       (452

Investment real-estate

     0       (26     1       (47

Joint ventures and limited partnerships

     (12     9       (36     (44

Derivatives(1)

     (122     123       2,208       51  

Other

     8       5       15       16  
                                

Realized investment gains (losses), net

   $ 29     $ (444   $ 2,204     $ (2,577
                                

 

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

 

Net Unrealized Investment Gains (Losses)

 

Net unrealized investment gains and losses on securities classified as “available for sale” and certain other long-term investments and other assets are included in the Consolidated Statements of Financial Position as a component of “Accumulated other comprehensive income (loss),” or “AOCI.” Changes in these amounts include reclassification adjustments to exclude from “Other comprehensive income (loss)” those items that are included

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

as part of “Net income” for a period that had been part of “Other comprehensive income (loss)” in earlier periods. The amounts for the periods indicated below, split between amounts related to fixed maturity securities on which an OTTI loss has been recognized, and all other net unrealized investment gains and losses, are as follows:

 

Net Unrealized Investment Gains and Losses on Fixed Maturity Securities on which an OTTI loss has been recognized

 

    Net Unrealized
Gains (Losses) on
Investments
    Deferred Policy
Acquisition
Costs, Deferred
Sales
Inducements,
and Valuation
of Business
Acquired
    Future
Policy
Benefits
    Policyholders’
Dividends
    Deferred
Income Tax
(Liability)
Benefit
    Accumulated
Other
Comprehensive
Income (Loss)
Related To Net
Unrealized
Investment
Gains (Losses)
 
    (in millions)  

Balance, December 31, 2009

  $ (1,229   $ 193     $ 2     $ 0     $ 355     $ (679

Net investment gains (losses) on investments arising during the period

    (178           62       (116

Reclassification adjustment for (gains) losses included in net income

    254             (89     165  

Reclassification adjustment for OTTI losses excluded from net income(1)

    (34           12       (22

Impact of net unrealized investment (gains) losses on deferred policy acquisition costs, deferred sales inducements and valuation of business acquired

      (144         50       (94

Impact of net unrealized investment (gains) losses on future policy benefits

        (12       4       (8

Impact of net unrealized investment (gains) losses on policyholders’ dividends

          450       (158     292  
                                               

Balance, September 30, 2010

  $ (1,187   $ 49     $ (10   $ 450     $ 236     $ (462
                                               

 

(1) Represents “transfers in” related to the portion of OTTI losses recognized during the period that were not recognized in earnings for securities with no prior OTTI loss.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

All Other Net Unrealized Investment Gains and Losses in AOCI

 

    Net Unrealized
Gains (Losses) on
Investments(1)
    Deferred Policy
Acquisition
Costs, Deferred
Sales
Inducements,
and Valuation
of Business
Acquired
    Future
Policy
Benefits
    Policyholders’
Dividends
    Deferred
Income Tax
(Liability)
Benefit
    Accumulated
Other
Comprehensive
Income (Loss)
Related To Net
Unrealized
Investment
Gains (Losses)
 
    (in millions)  

Balance, December 31, 2009

  $ 2,885     $ (803   $ (509   $ 0     $ (383   $ 1,190  

Net investment gains (losses) on investments arising during the period

    11,881             (4,066     7,815  

Reclassification adjustment for (gains) losses included in net income

    (208           73       (135

Reclassification adjustment for OTTI losses excluded from net income(2)

    34             (12     22  

Impact of net unrealized investment (gains) losses on deferred policy acquisition costs, deferred sales inducements and valuation of business acquired

      (612         214       (398

Impact of net unrealized investment (gains) losses on future policy benefits

        (708       248       (460

Impact of net unrealized investment (gains) losses on policyholders’ dividends

          (3,603     1,261       (2,342
                                               

Balance, September 30, 2010

  $ 14,592     $ (1,415   $ (1,217   $ (3,603   $ (2,665   $ 5,692  
                                               

 

(1) Includes cash flow hedges. See Note 14 for information on cash flow hedges.
(2) Represents “transfers out” related to the portion of OTTI losses recognized during the period that were not recognized in earnings for securities with no prior OTTI loss.

 

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

 

     September 30,
2010
    December 31,
2009
 
     (in millions)  

Fixed maturity securities on which an OTTI loss has been recognized

   $ (1,187   $ (1,229

Fixed maturity securities, available for sale—all other

     13,790       2,203  

Equity securities, available for sale

     904       789  

Derivatives designated as cash flow hedges(1)

     (293     (317

Other investments(2)

     191       210  
                

Net unrealized gains (losses) on investments

   $ 13,405     $ 1,656  
                

 

(1) See Note 14 for more information on cash flow hedges.
(2) Includes $242 million of net unrealized losses on held to maturity securities that were transferred from available for sale. Also includes net unrealized gains on certain joint ventures that are strategic in nature and are included in “Other assets.”

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Duration of Gross Unrealized Loss Positions for Fixed Maturities

 

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

 

     September 30, 2010  
     Less than twelve months      Twelve months or more      Total  
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
     (in millions)  

Fixed maturities(1)

  

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

   $ 623      $ 3      $ 468      $ 40      $ 1,091      $ 43  

Obligations of U.S. states and their political subdivisions

     55        2        49        1        104        3  

Foreign government bonds

     487        3        115        17        602        20  

Corporate securities

     5,489        266        10,603        1,763        16,092        2,029  

Commercial mortgage-backed securities

     132        2        382        59        514        61  

Asset-backed securities

     933        18        5,771        2,106        6,704        2,124  

Residential mortgage-backed securities

     331        3        501        66        832        69  
                                                     

Total

   $ 8,050      $ 297      $ 17,889      $ 4,052      $ 25,939      $ 4,349  
                                                     

 

(1) Includes $600 million of fair value and $94 million of gross unrealized losses at September 30, 2010 on securities classified as held to maturity, a portion of which are not reflected in accumulated other comprehensive income.

 

     December 31, 2009  
     Less than twelve months      Twelve months or more      Total  
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
     (in millions)  

Fixed maturities(2)

  

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

   $ 4,058      $ 259      $ 475      $ 111      $ 4,533      $ 370  

Obligations of U.S. states and their political subdivisions

     936        42        7        0        943        42  

Foreign government bonds(1)

     5,251        101        515        42        5,766        143  

Corporate securities(1)

     10,164        346        17,397        2,519        27,561        2,865  

Commercial mortgage-backed securities

     1,471        40        3,216        180        4,687        220  

Asset-backed securities

     1,619        565        6,128        1,942        7,747        2,507  

Residential mortgage-backed securities

     1,567        21        1,150        114        2,717        135  
                                                     

Total

   $ 25,066      $ 1,374      $ 28,888      $ 4,908      $ 53,954      $ 6,282  
                                                     

 

(1) Includes reclassifications to conform to current period presentation.
(2) Includes $1,216 million of fair value and $133 million of gross unrealized losses at December 31, 2009 on securities classified as held to maturity, a portion of which are not reflected in accumulated other comprehensive income.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

The gross unrealized losses at September 30, 2010 and December 31, 2009 are composed of $2,734 million and $4,240 million related to high or highest quality securities based on NAIC or equivalent rating and $1,615 million and $2,042 million related to other than high or highest quality securities based on NAIC or equivalent rating. At September 30, 2010, $2,711 million of the gross unrealized losses represented declines in value of greater than 20%, $643 million of which had been in that position for less than six months, as compared to $3,594 million at December 31, 2009, that represented declines in value of greater than 20%, $588 million of which had been in that position for less than six months. At September 30, 2010, the $4,052 million of gross unrealized losses of twelve months or more were concentrated in asset-backed securities, and in the manufacturing, services, and finance sectors of the Company’s corporate securities. At December 31, 2009, the $4,908 million of gross unrealized losses of twelve months or more were concentrated in asset-backed securities, and in the manufacturing and finance sectors of the Company’s corporate securities. In accordance with its policy described in Note 2, the Company concluded that an adjustment to earnings for other-than-temporary impairments for these securities was not warranted at September 30, 2010 or December 31, 2009. These conclusions are based on a detailed analysis of the underlying credit and cash flows on each security. The gross unrealized losses are primarily attributable to credit spread widening and increased liquidity discounts. At September 30, 2010, the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before the anticipated recovery of its remaining amortized cost basis.

 

Duration of Gross Unrealized Loss Positions for Equity Securities

 

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

 

     September 30, 2010  
     Less than twelve months      Twelve months or more      Total  
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
     (in millions)  

Equity securities, available for sale

   $ 1,447      $ 142      $ 348      $ 37      $ 1,795      $ 179  
                                                     
     December 31, 2009  
     Less than twelve months      Twelve months or more      Total  
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
     (in millions)  

Equity securities, available for sale

   $ 1,159      $ 142      $ 754      $ 83      $ 1,913      $ 225  
                                                     

 

At September 30, 2010, $58 million of the gross unrealized losses represented declines of greater than 20%, $42 million of which had been in that position for less than six months. At December 31, 2009, $62 million of the gross unrealized losses represented declines of greater than 20%, $37 million of which had been in that position for less than six months. Perpetual preferred securities have characteristics of both debt and equity securities. Since an impairment model similar to fixed maturity securities is applied to these securities, an other-than-temporary impairment has not been recognized on certain perpetual preferred securities that have been in a continuous unrealized loss position for twelve months or more as of September 30, 2010, and December 31, 2009. In accordance with its policy described in Note 2, the Company concluded that an adjustment for other-than-temporary impairments for these equity securities was not warranted at September 30, 2010 or December 31, 2009.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

5. VARIABLE INTEREST ENTITIES

 

In the normal course of its activities, the Company enters into relationships with various special purpose entities and other entities that are deemed to be variable interest entities (“VIEs”). A VIE is an entity that either (1) has equity investors that lack certain essential characteristics of a controlling financial interest (including the ability to control activities of the entity, the obligation to absorb the entity’s expected losses and the right to receive the entity’s expected residual returns) or (2) lacks sufficient equity to finance its own activities without financial support provided by other entities, which in turn would be expected to absorb at least some of the expected losses of the VIE.

 

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

 

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

 

Consolidated Variable Interest Entities for which the Company is the Sponsor

 

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

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

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

 

     September 30,
2010
     December 31,
2009
 
     (in millions)  

Fixed maturities, available for sale

   $ 58      $ 68  

Trading account assets supporting insurance liabilities

     9        7  

Commercial mortgage and other loans

     356        412  

Other long-term investments

     3        10  

Cash and cash equivalents

     88        44  

Accrued investment income

     2        2  

Other assets

     3        4  

Separate account assets

     19        38  
                 

Total assets of consolidated VIEs

   $ 538      $ 585  
                 

Other liabilities

     380        413  

Separate account liabilities

     19        38  
                 

Total liabilities of consolidated VIEs

   $ 399      $ 451  
                 

 

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

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Other Consolidated Variable Interest Entities

 

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

 

     September 30,
2010
    December 31,
2009
 
     (in millions)  

Fixed maturities, available for sale

   $ 119     $ 107  

Fixed maturities, held to maturity

     1,097       985  

Other trading account assets

     0       0  

Other long-term investments

     (40     (48

Cash and cash equivalents

     0       0  

Accrued investment income

     4       4  

Other assets

     0       0  
                

Total assets of consolidated VIEs

   $ 1,180     $ 1,048  
                

Total liabilities of consolidated VIEs

   $ 0     $ 0  
                

 

In addition, not reflected in the table above, the Company has created a trust that is a VIE, to facilitate Prudential Insurance’s Funding Agreement Notes Issuance Program (“FANIP”). The trust issues medium-term notes secured by funding agreements issued to the trust by Prudential Insurance with the proceeds of such notes. The trust is the beneficiary of an indemnity agreement with the Company that provides that the Company is responsible for costs related to the notes issued with limited exception. As a result, the Company has determined that it is the primary beneficiary of the trust, which is therefore consolidated.

 

The funding agreements represent an intercompany transaction that is eliminated upon consolidation. However, in recognition of the security interest in such funding agreements, the trust’s medium-term note liability of $3,509 million and $4,927 million at September 30, 2010 and December 31, 2009, respectively, is classified within “Policyholders’ account balances.” Creditors of the trust have recourse to Prudential Insurance if the trust fails to make contractual payments on the medium-term notes. The Company has not provided material financial or other support that was not contractually required to the trust.

 

Unconsolidated Variable Interest Entities

 

The Company has determined that it is not the primary beneficiary of certain VIEs that it sponsors, including certain CDOs and other investment structures, as it does not have both (1) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (2) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant. The Company’s maximum exposure to loss resulting from its relationship with unconsolidated VIEs it sponsors is limited to its investment in the VIEs, which was $507

 

28


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

million and $452 million at September 30, 2010 and December 31, 2009, respectively. These investments are reflected in “Fixed maturities, available for sale,” “Other trading account assets, at fair value” and “Other long-term investments.” The fair value of assets held within these unconsolidated VIEs was $8,163 million and $8,194 million as of September 30, 2010 and December 31, 2009, respectively. There are no liabilities associated with these unconsolidated VIEs on the Company’s balance sheet.

 

In the normal course of its activities, the Company will invest in joint ventures and limited partnerships. These ventures include hedge funds, private equity funds and real estate related funds and may or may not be VIEs. The Company’s maximum exposure to loss on these investments, both VIEs and non-VIEs, is limited to the amount of its investment. The Company has determined that it is not required to consolidate these entities because either (1) it does not control them or (2) it does not have the obligation to absorb losses of the entities that could be potentially significant to the entities or the right to receive benefits from the entities that could be potentially significant. The Company classifies these investments as “Other long-term investments” and its maximum exposure to loss associated with these entities was $3,403 million and $3,251 million as of September 30, 2010 and December 31, 2009, respectively.

 

In addition, in the normal course of its activities, the Company will invest in structured investments including VIEs for which it is not the sponsor. These structured investments typically invest in fixed income investments and are managed by third parties and include asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The Company’s maximum exposure to loss on these structured investments, both VIEs and non-VIEs, is limited to the amount of its investment. See Note 4 for details regarding the carrying amounts and classification of these assets. The Company has not provided material financial or other support that was not contractually required to these structures. The Company has determined that it is not the primary beneficiary of these structures due to the fact that it does not control these entities.

 

Included among these structured investments are asset-backed securities issued by VIEs that manage investments in the European market. In addition to a stated coupon, each investment provides a return based on the VIE’s portfolio of assets and related investment activity. The market value of these VIEs was approximately $6.1 billion and $7.5 billion as of September 30, 2010 and December 31, 2009, respectively, and these VIEs were financed primarily through the issuance of notes similar to those purchased by the Company. The Company generally accounts for these investments as available for sale fixed maturities containing embedded derivatives that are bifurcated and marked-to-market through “Realized investment gains (losses), net,” based upon the change in value of the underlying portfolio. The Company’s variable interest in each of these VIEs represents less than 50% of the only class of variable interests issued by the VIE. The Company’s maximum exposure to loss from these interests was $750 million and $723 million at September 30, 2010 and December 31, 2009, respectively, which includes the fair value of the embedded derivatives.

 

6. 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

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 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, which would be intended to increase future actual earnings until the actual cumulative earnings equaled the expected cumulative earnings.

 

As of September 30, 2010, the Company did not recognize a cumulative earnings policyholder dividend obligation since actual cumulative earnings were below the expected cumulative earnings by $64 million. However, accumulated net unrealized investment gains that have arisen subsequent to the establishment of the Closed Block have been reflected as a policyholder dividend obligation of $3.149 billion at September 30, 2010, to be paid to Closed Block policyholders unless offset by future experience, with an offsetting amount reported in “Accumulated other comprehensive income (loss).” As of December 31, 2009, actual cumulative earnings were below the expected cumulative earnings, thereby eliminating the policyholder dividend obligation. Furthermore, the accumulation of net unrealized investment gains as of December 31, 2009 that had arisen subsequent to the establishment of the Closed Block, were not sufficient to overcome the cumulative earnings shortfall. See the table below for changes in the components of the policyholder dividend obligation for the nine months ended September 30, 2010.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

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:

 

     September 30,
2010
    December 31,
2009
 
     (in millions)  

Closed Block Liabilities

    

Future policy benefits

   $ 51,597     $ 51,774  

Policyholders’ dividends payable

     971       926  

Policyholders’ dividend obligation

     3,149       0  

Policyholders’ account balances

     5,545       5,588  

Other Closed Block liabilities

     4,607       4,300  
                

Total Closed Block Liabilities

     65,869       62,588  
                

Closed Block Assets

    

Fixed maturities, available for sale, at fair value

     41,744       38,448  

Other trading account assets, at fair value

     156       166  

Equity securities, available for sale, at fair value

     3,200       3,037  

Commercial mortgage and other loans

     7,814       7,751  

Policy loans

     5,397       5,418  

Other long-term investments

     1,660       1,597  

Short-term investments

     995       1,218  
                

Total investments

     60,966       57,635  

Cash and cash equivalents

     758       662  

Accrued investment income

     643       608  

Other Closed Block assets

     474       307  
                

Total Closed Block Assets

     62,841       59,212  
                

Excess of reported Closed Block Liabilities over Closed Block Assets

     3,028       3,376  

Portion of above representing accumulated other comprehensive income:

    

Net unrealized investment gains (losses)

     3,175       231  

Allocated to policyholder dividend obligation

     (3,149     0  
                

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

   $ 3,054     $ 3,607  
                

 

Information regarding the policyholder dividend obligation is as follows:

 

     Nine Months Ended
September 30, 2010
 
     (in millions)  

Balance, January 1

   $ 0  

Impact from earnings allocable to policyholder dividend obligation

     0  

Change in net unrealized investment gains (losses) allocated to policyholder dividend obligation

     3,149  
        

Balance, September 30

   $ 3,149  
        

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Closed Block revenues and benefits and expenses for the three and nine months ended September 30, 2010 and 2009 were as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010              2009      
     (in millions)  

Revenues

         

Premiums

   $ 684     $ 738     $ 2,191      $ 2,378  

Net investment income

     751       733       2,226        2,161  

Realized investment gains (losses), net

     66       (22     766        (1,250

Other income

     32       36       31        88  
                                 

Total Closed Block revenues

     1,533       1,485       5,214        3,377  
                                 

Benefits and Expenses

         

Policyholders’ benefits

     811       839       2,572        2,743  

Interest credited to policyholders’ account balances

     35       36       105        106  

Dividends to policyholders

     480       539       1,462        795  

General and administrative expenses

     136       139       407        427  
                                 

Total Closed Block benefits and expenses

     1,462       1,553       4,546        4,071  
                                 

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

     71       (68     668        (694

Income tax expense (benefit)

     (41     (6     116        (8
                                 

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

     112       (62     552        (686

Income from discontinued operations, net of taxes

     1       0       1        0  
                                 

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

   $ 113     $ (62   $ 553      $ (686
                                 

 

7. 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, 2009

     641.8        179.7       462.1        2.0  

Common Stock issued

     0.0        0.0       0.0        0.0  

Common Stock acquired

     0.0        0.0       0.0        0.0  

Stock-based compensation programs(1)

     0.0        (2.9     2.9        0.0  
                                  

Balance, September 30, 2010

     641.8        176.8       465.0        2.0  
                                  

 

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

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Comprehensive Income

 

The components of comprehensive income (loss) are as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
         2010              2009              2010             2009      
     (in millions)  

Net income

   $ 1,242      $ 1,032      $ 3,017     $ 1,215  

Other comprehensive income (loss), net of taxes:

          

Change in foreign currency translation adjustments

     509        333        415       193  

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

     1,997        4,763        4,719       7,865  

Change in pension and postretirement unrecognized net periodic benefit

     3        8        41       26  
                                  

Other comprehensive income(2)

     2,509        5,104        5,175       8,084  
                                  

Comprehensive income

     3,751        6,136        8,192       9,299  
                                  

Comprehensive (income) loss attributable to noncontrolling interests

     22        42        (2     61  
                                  

Comprehensive income attributable to Prudential Financial, Inc.

   $ 3,773      $ 6,178      $ 8,190     $ 9,360  
                                  

 

(1) Includes cash flow hedges of $(119) million and $(36) million for the three months ended September 30, 2010 and 2009, respectively and $16 million and $(66) million for the nine months ended September 30, 2010 and 2009, respectively. See Note 4 for additional information regarding unrealized investment gains (losses), including the split between amounts related to fixed maturity securities on which an other-than-temporary impairment loss has been recognized, and all other unrealized investment gains (losses).
(2) Amounts are net of tax expense of $1,084 million and $2,578 million for the three months ended September 30, 2010 and 2009, respectively and $2,507 million and $4,070 million for the nine months ended September 30, 2010 and 2009, respectively.

 

The balance of and changes in each component of “Accumulated other comprehensive income (loss) attributable to Prudential Financial, Inc.” for the nine months ended September 30, 2010 and 2009 are as follows (net of taxes):

 

     Accumulated Other Comprehensive Income (Loss) Attributable to
Prudential Financial, Inc.
 
     Foreign Currency
Translation
Adjustment
     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, 2009

   $ 674      $ 511      $ (1,628   $ (443

Change in component during period

     412        4,719        41       5,172  
                                  

Balance, September 30, 2010

   $ 1,086      $ 5,230      $ (1,587   $ 4,729  
                                  

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     Accumulated Other Comprehensive Income (Loss) Attributable to
Prudential Financial, Inc.
 
     Foreign Currency
Translation
Adjustment
     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, 2008

   $ 375      $ (6,735   $ (983   $ (7,343

Change in component during period

     210        7,865       26       8,101  

Impact of adoption of guidance for other-than- temporary impairments of debt securities(2)

     0        (659     0       (659
                                 

Balance, September 30, 2009

   $ 585      $ 471     $ (957   $ 99  
                                 

 

(1) Includes cash flow hedges of $(189) million and $(205) million as of September 30, 2010 and December 31, 2009, respectively and $(213) million and $(147) million as of September 30, 2009 and December 31, 2008, respectively. See Note 4 for additional information regarding unrealized investment gains (losses), including the split between amounts related to fixed maturity securities on which an other-than-temporary impairment loss has been recognized, and all other unrealized investment gains (losses).
(2) See Note 2 for additional information on the adoption of guidance for other-than-temporary impairments of debt securities.

 

8. 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.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

 

Common Stock

 

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

 

     Three Months Ended September 30,  
     2010      2009  
     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

   $ 1,158           $ 1,040       

Direct equity adjustment

     9             12       

Less: Income (loss) attributable to noncontrolling interests

     (2           (50     

Less: Earnings allocated to participating unvested share-based payment awards

     15             12       
                           

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

   $ 1,154       464.8      $ 2.48      $ 1,090       461.2      $ 2.36  
                                                   

Effect of dilutive securities and compensation programs

               

Add: Earnings allocated to participating unvested share-based payment awards—Basic

   $ 15           $ 12       

Less: Earnings allocated to participating unvested share-based payment awards—Diluted

     15             12       

Stock options

       2.9             2.4     

Deferred and long-term compensation programs

       0.4             0.3     

Exchangeable Surplus Notes

     4       5.1           1       0.7     
                                       

Diluted earnings per share

               

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

   $ 1,158       473.2      $ 2.45      $ 1,091       464.6      $ 2.35  
                                                   

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     Nine Months Ended September 30,  
     2010      2009  
     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

   $ 2,495           $ 1,553       

Direct equity adjustment

     29             34       

Less: Income (loss) attributable to noncontrolling interests

     (1           (44     

Less: Earnings allocated to participating unvested share-based payment awards

     33             18       
                           

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

   $ 2,492       464.0      $ 5.37      $ 1,613       438.8      $ 3.68  
                                                   

Effect of dilutive securities and compensation programs

               

Add: Earnings allocated to participating unvested share-based payment awards—Basic

   $ 33           $ 18       

Less: Earnings allocated to participating unvested share-based payment awards—Diluted

     32             18       

Stock options

       3.1             1.2     

Deferred and long-term compensation programs

       0.5             0.6     

Exchangeable Surplus Notes

     13       5.1           0       0.0     
                                       

Diluted earnings per share

               

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

   $ 2,506       472.7      $ 5.30      $ 1,613       440.6      $ 3.66  
                                                   

 

Unvested share-based payment awards that contain nonforfeitable rights to dividends are participating securities and included in the computation of earnings per share pursuant to the two-class method. Under this method, earnings of the Financial Services Businesses attributable to Prudential Financial, Inc. are allocated between Common Stock and the participating awards, as if the awards were a second class of stock. Undistributed earnings allocated to participating unvested share-based payment awards for the three months ended September 30, 2010 and 2009 were based on 6.2 million and 5.3 million of such awards, respectively, weighted for the period they were outstanding. Undistributed earnings allocated to participating unvested share-based payment awards for the nine months ended September 30, 2010 and 2009 were based on 6.1 million and 4.9 million of such awards, respectively, weighted for the period they were outstanding. The computation of earnings per share of Common Stock excludes the dilutive impact of participating unvested share-based awards based on the application of the two-class method.

 

For the three months ended September 30, 2010 and 2009, 11.2 million and 10.4 million options, respectively, weighted for the portion of the period they were outstanding, with a weighted average exercise price of $70.65 and $72.65 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. For the nine months ended September 30, 2010 and 2009, 10.3 million and 14.1 million options, respectively, weighted for the

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

portion of the period they were outstanding, with a weighted average exercise price of $72.00 and $62.87 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.

 

In September 2009, the Company issued $500 million of surplus notes with an interest rate of 5.36% per annum which are exchangeable at the option of the note holders for shares of Common Stock. The exchange rate used in the diluted earnings per share calculation for the surplus notes is 10.1235 shares of Common Stock per each $1,000 principal amount of surplus notes. In calculating diluted earnings per share under the if-converted method, the potential shares that would be issued assuming a hypothetical exchange, weighted for the period the notes are outstanding, is added to the denominator, and interest expense, net of tax, is added to the numerator, if the overall effect is dilutive. For the nine months ended September 30, 2009, the hypothetical impact of these shares was antidilutive and therefore excluded from the computation of diluted earnings per share.

 

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. As of September 30, 2010, $2 million of senior notes related to the $2.0 billion December 2006 issuance remain outstanding. These will be dilutive to earnings per share if the average market price of the Common Stock for a particular period is above the initial conversion price of $104.21. As of September 30, 2010, $0.2 million of senior notes related to the $3.0 billion December 2007 issuance remain outstanding. These senior notes will be dilutive to earnings per share if the average market price of the Common Stock for a particular period is above the initial conversion price of $132.39.

 

Class B Stock

 

Income (loss) from continuing operations per share of Class B Stock for the three and nine months ended September 30, are presented below. There are no potentially dilutive shares associated with the Class B Stock.

 

     Three Months Ended September 30,  
     2010      2009  
     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 (loss) from continuing operations attributable to the Closed Block Business

   $ 76            $ (8     

Less: Direct equity adjustment

     9              12       
                            

Income (loss) from continuing operations attributable to the Closed Block Business available to holders of Class B Stock after direct equity adjustment

   $ 67        2.0      $ 33.50      $ (20     2.0      $ (10.00
                                                    

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     Nine Months Ended September 30,  
     2010      2009  
     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 (loss) from continuing operations attributable to the Closed Block Business

   $ 516            $ (364     

Less: Direct equity adjustment

     29              34       
                            

Income (loss) from continuing operations attributable to the Closed Block Business available to holders of Class B Stock after direct equity adjustment

   $ 487        2.0      $ 243.50      $ (398     2.0      $ (199.00
                                                    

 

9. SHORT-TERM AND LONG-TERM DEBT

 

Commercial Paper

 

The Company issues commercial paper under the two programs described below primarily to manage operating cash flows and existing commitments, to meet working capital needs and to take advantage of current investment opportunities. At September 30, 2010 and December 31, 2009, the weighted average maturity of total commercial paper outstanding was 35 and 27 days, respectively.

 

Prudential Financial has a commercial paper program rated A-1 by Standard & Poor’s Rating Services (“S&P”), P-2 by Moody’s Investors Service, Inc. (“Moody’s”) and F2 by Fitch Ratings Ltd. (“Fitch”) as of September 30, 2010.

 

Prudential Funding, LLC, a wholly owned subsidiary of Prudential Insurance has a commercial paper program, rated A-1+ by S&P, P-2 by Moody’s and F1 by Fitch as of September 30, 2010. Prudential Financial has issued a subordinated guarantee covering Prudential Funding’s domestic commercial paper program.

 

Both commercial paper programs are backed by our unsecured committed lines of credit. As of September 30, 2010, Prudential Financial, Prudential Insurance and Prudential Funding had unsecured committed lines of credit totaling $3.9 billion, which reflects a reduction from $4.3 billion effective July 15, 2010, in connection with an amendment to certain terms and conditions of the credit facilities. There were no outstanding borrowings under these facilities as of September 30, 2010.

 

The table below presents the Company’s total outstanding commercial paper borrowings as of the dates indicated:

 

     September 30,
2010
     December 31,
2009
 
     (in millions)  

Prudential Financial

   $ 249      $ <