management’s discussion and analysis of … sap, the commissioner's reserve valuation method...
TRANSCRIPT
Annex 1
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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF PICA
AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2009
(See Annex A for definitions of certain terms used in this Management‘s Discussion and Analysis)
Summary of Principal Differences between SAP and GAAP
The financial information for The Prudential Insurance Company of America (―PICA‖) in this
Management‘s Discussion and Analysis has been prepared in accordance with SAP. SAP differs in certain
respects, which in some cases may be material, from GAAP.
The significant differences between SAP and GAAP are noted below:
The SAP financial statements of PICA are not consolidated with those of its subsidiaries. The
value of its subsidiaries are recorded as Preferred Stock, Common Stock and Other Invested
Assets.
Under SAP, policy acquisition costs, such as commissions, and other costs incurred in
connection with acquiring new business, are expensed when incurred; under GAAP, such costs
are deferred and amortized either over the expected lives of the contracts, based on the level and
timing of either gross margins, gross profits or gross premiums, depending on the type of
contract.
Under SAP, the Commissioner's Reserve Valuation Method is used for the majority of
individual insurance reserves; under GAAP, individual insurance policyholder liabilities for
traditional forms of insurance are generally established using the net level premium method.
For interest-sensitive policies, a liability for policyholder account balances is established under
GAAP based on the contract value that has accrued to the benefit of the policyholder. Policy
assumptions used in the estimation of policyholder liabilities are generally prescribed under
SAP; under GAAP, policy assumptions are based upon best estimates as of the date the policy is
issued, with provisions for the risk of adverse deviation.
Under SAP, the Commissioner's Annuity Reserve Valuation Method is used for the majority of
individual deferred annuity reserves; under GAAP, individual deferred annuity policyholder
liabilities are generally equal to the contract value that has accrued to the benefit of the
policyholder, together with liabilities for certain guarantees under variable annuity contracts.
Under SAP, reinsurance reserve credits taken by ceding entities as a result of reinsurance
contracts are netted against the ceding entity‘s policy and claim reserves and unpaid claims;
under GAAP, reinsurance recoverables are reported as assets.
Under SAP, an interest maintenance reserve ("IMR") is established to capture realized
investment gains and losses, net of tax, on the sale of bonds and is amortized into income over
the remaining years to expected maturity of the assets sold or impaired; under GAAP, no such
reserve is required. See discussion under ―Impairments of Bonds‖ related to changes in PICA‘s
impairment policy.
Under SAP, an asset valuation reserve ("AVR") based upon a formula prescribed by the NAIC
is established as a liability to offset potential investment losses, and changes in the AVR are
charged or credited directly to surplus; under GAAP, no such reserve is required.
Under SAP, investments in bonds and preferred stocks are generally carried at amortized cost;
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under GAAP, investments in bonds and preferred stocks, other than those classified as held to
maturity, are carried at fair value.
Under SAP, certain assets designated as non-admitted are excluded from assets by a direct
charge to surplus; under GAAP, such assets are carried on the balance sheet with appropriate
valuation allowances.
Under SAP, surplus notes are recorded as a component of surplus; under GAAP, surplus notes
are recorded as a liability.
Under SAP, an extraodinary distribution approved by PICA‘s regulator may be recorded as a
return of capital; under GAAP, the distribution is recorded as a dividend when PICA has
undistributed retained earnings.
Under SAP, goodwill is subject to admissability limits and is amortized over a period not to
exceed ten years; under GAAP, goodwill is subject to impairment testing and not amortized.
Under SAP, income tax expense is based upon taxes currently payable. Changes in deferred
taxes are reported in surplus and subject to admissability limits; under GAAP, changes in
deferred taxes are generally recorded in income tax expense.
Under SAP, charges recorded for pension and postretirement health benefits only include
charges for vested employees; under GAAP, charges for pension and postretirement health
benefits include charges for both vested and non-vested employees.
Under SAP, deposits to universal life contacts and limited payment contracts are credited to
revenue; under GAAP, such deposits are reported as policyholder account balances.
Under SAP, interest-related other-than-temporary impairments for bonds are determined based
primarily upon the Company‘s intent to sell; under GAAP, interest-related other-than-temporary
impairments for debt securities are based primarily upon whether we intend to sell the security
or more likely than not will be required to sell the security before recovery of its amortized cost
basis.
Overview
PICA is one of the largest insurance companies in the United States. The principal products and services of
PICA include individual life insurance and annuities, group insurance and pension and retirement products and
related services and administration. The results in the analysis below include the results of the Closed Block
business, which comprises the assets and related liabilities of the Closed Block, defined below. The principal
executive offices of PICA are located in Newark, New Jersey.
At March 31, 2009, PICA's admitted assets were $228 billion (including $80 billion held in separate
accounts), compared to $237 billion (including $88 billion held in separate accounts) at December 31, 2008.
Excluding separate accounts, assets were primarily comprised of a mix of bonds, mortgage loans, contract loans,
cash and short-term investments, and equity investments designed to match the cash flow requirements of
insurance liabilities.
Demutualization
On the date of the demutualization, PICA converted from a mutual life insurance company to a stock life
insurance company and became a direct, wholly owned subsidiary of PH, a wholly owned subsidiary of PFI.
The demutualization was carried out under PICA‘s Plan of Reorganization, dated as of December 15, 2000, as
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amended.
On the date of the demutualization, PFI completed an initial public offering of its Common Stock, as well as
the sale of shares of Class B Stock, a separate class of common stock, through a private placement. In addition,
on the date of the demutualization, PH, which owns the capital stock of PICA, issued $1.75 billion in senior
secured notes (the "IHC debt"). A portion of the IHC debt was insured by a bond insurer.
The Plan of Reorganization required PICA to establish and operate a regulatory mechanism known as the
―Closed Block.‖ The policies that are included in the Closed Block (the "Closed Block Policies") are specified
participating individual life insurance policies and individual annuity contracts that were in force on the date of
the demutualization and on which PICA was paying or expected to pay experience-based policy dividends. The
Closed Block is designed generally to provide for the reasonable expectations of holders of participating
individual life insurance policies and annuities included in the Closed Block for future policy dividends after
demutualization by allocating assets that will be used for payment of benefits, including policyholder dividends,
on these policies. The Plan of Reorganization provided that PICA may, with the prior consent of the
Commissioner, enter into agreements to transfer to a third party all or any part of the risks under the Closed
Block Policies. As of December 31, 2008, PICA had reinsurance agreements covering 90% of the Closed Block
Policies, including 17% with an affiliate.
Results of Operations
Net (Loss) Income
2009 to 2008 Three Month Comparison. Net income (loss) increased $710 million from $238 million of net
loss for the three months ended March 31, 2008 to net income of $472 million for the three months ended March
31, 2009. The increase in net income (loss) between years was primarily driven by an increase in operating
income before income taxes of $501 million principally driven by an increase of $361 million in the Retirement
business between periods mainly as a result of the termination during the first quarter of 2009 of funding
agreements previously issued by PICA to PFI. The termination of these funding agreements resulted in a net
gain of $285 million for PICA. Operating income before income taxes in the individual life and annuity business
increased $57 million between periods primarily driven by a $232 million net gain due to negative reinsurance
treaty experience related to the modified co-insurance (―MODCO‖) agreements of the Closed Block business.
These MODCO agreements require payment from the reinsurers in the event of unfavorable investment
experience in the Closed Block business that is not absorbed by adjustments to policyholder dividends. As a
result of this negative reinsurance treaty experience, future positive experience would require payments to the
reinsurer. Also contributing to the gain between periods was a reduction in the 2009 dividend scale related to the
Closed Block business. Partially offsetting these gains was a decrease in deferred premiums between years
related to a reserve valuation basis change and an increase in minimum death benefit guarantee reserve charges.
Corporate and other business operating income before taxes increased $49 million between periods primarily
driven by an increase in affiliated bond income mainly due to the note established as a result of PFI‘s
contribution of Prudential Securities Group, LLC (―PSG Holdings, LLC‖) to PICA during the fourth quarter of
2008 and a decline in interest expense on borrowed money. Additionally, group insurance operating income
before taxes increased $23 million between years, which primarily reflects the favorable experience in the group
life, disability and long-term care businesses.
The income tax provision decreased from $45 million to ($120) million between years and was mainly due to
the following two items: (1) a decline in the PICA‘s effective tax rate primarily driven by permanent tax
adjustments in the current period, principally the exclusion of the net gain resulting from the termination of
funding agreements previously issued by PICA to PFI, and (2) the net benefit from the release of liabilities
previously provided for uncertain tax positions as a result of the settlement of an IRS examination in 2009,
including a decrease in interest expense accrued on uncertain tax positions.
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Net income (loss) also included a decrease in net realized capital (losses) of $44 million, from ($330) million
for the three months ended March 31, 2008 to ($286) million for the three months ended March 31, 2009. Net
realized capital losses included $534 million and $494 million of other-than-temporary impairments for the three
months ended March 31, 2009 and 2008, respectively. The decline in net realized capital losses is further
discussed below under ―Capital (Losses)‖. See discussion under ―Impairments of Bonds‖ related to changes in
PICA‘s impairment policy.
Change in Statutory Capital and Surplus
2009 to 2008 Three Month Comparison. Statutory capital (surplus plus asset valuation reserve) decreased
$309 million, from $7,679 million at December 31, 2008 to $7,370 million at March 31, 2009. The change in
capital and surplus for the three months ended March 31, 2009 was primarily driven by:
A ($651) million change in net unrealized capital (losses) mainly due to losses on derivative instruments
and unaffiliated bond losses during the first quarter of 2009. The change in net unrealized (losses) is
further discussed below under ―Capital (Losses)‖; and
A ($223) million change in net deferred taxes. For interim reporting, the change in net deferred taxes is
computed using an estimated annual effective tax rate. This rate is computed as the ratio of projected
change in net deferred tax assets for the entire year over projected statutory pre-tax net income for the
year. The rate used for interim reporting will vary period over period as projected reversal and
generation of deferred tax assets or liabilities and projected statutory pre-tax income for the year is
updated based on the best information available as of the reporting date.
Partially offset by:
A $472 million of net income, as discussed above.
The remaining $93 million change in capital and surplus during the three months ended March 31, 2009 was
driven by a decline in certain non-admitted assets, such as the prepaid pension asset and non-admitted deferred
taxes. Additionally, changes in the valuation basis of reserves in individual life accounted for the remaining
change in capital and surplus.
Revenues
2009 to 2008 Three Month Comparison. Total revenues increased $208 million from $5,711 million for the
three months ended March 31, 2008 to $5,919 million for the three months ended March 31, 2009. The increase
in total revenues was primarily driven by an increase in other income of $373 million, from income of $150
million for the three months ended March 31, 2008 to income of $523 million for the three months ended March
31, 2009. The increase in other income is mainly due to the termination of funding agreements contracted
between PICA and PFI. The termination of these funding agreements resulted in a net gain of $285 million for
PICA. Additionally, the increase in other income was driven by a favorable $172 million change in adjustments
related to the MODCO agreements of the Closed Block business. The adjustments are based on formulas set
forth in these MODCO agreements that are mainly affected by investment experience. However, the net increase
in other income due to these MODCO agreements is more than offset by the net of similar adjustments in
premiums, benefits, expenses and dividends to policyholders. As a result, excluding the impact of negative
reinsurance treaty experience, the MODCO agreements of the Closed Block have a minimal impact on net gain
from operations. As discussed above under ―Net (Loss) Income‖ negative reinsurance treaty experience will
result in a net gain for PICA, which is recorded through premiums. Also contributing to the increase in revenues
was an increase between periods in net investment income, including IMR amortization, of $98 million from
$1,797 million for the three months ended March 31, 2008 to $1,895 million for the three months ended March
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31, 2009. The increase in net investment income was mainly driven by an increase in bond income. The increase
in other income and net investment income was partially offset by a decline in premiums of $263 million
between years from $3,764 million for the three months ended March 31, 2008 to $3,501 million for the three
months ended March 31, 2009. The change in premiums was primarily driven by:
A $245 million decline in the retirement business mainly due to a decline in separate account deposits by
institutional investors between years. Partially offsetting the decline was an increase in general account
contributions, which correlates with a shift to investments that offer more stable returns;
A $129 million decrease in individual life and annuity premiums was primarily driven by a decline in
deferred premiums related to the reserve valuation basis change in the individual life segment as discussed
above under ―Change in Statutory Capital and Surplus‖. Partially offsetting the decline was an increase in
premiums in the Closed Block business as a result of adjustments to the MODCO agreements, including the
impact of the negative reinsurance treaty experience.
Partially offset by:
A $77 million increase in premiums primarily due to growth in the group life and long term care businesses
in the current year.
A $34 million increase between years in the international insurance business principally driven by higher
premiums assumed from Prudential of Japan as a result of growth in the business.
Benefits
2009 to 2008 Three Month Comparison. Total benefits, surrenders and fund withdrawals decreased $212
million, from $5,190 million for the three months ended March 31, 2008 to $4,978 million for the three months
ended March 31, 2009. The decrease in total benefits, surrenders and fund withdrawals was primarily due to a
decrease of $215 million in the individual life and annuity business mainly driven by lower contract values
between years as a result of the equity market decline. Additionally, benefits, surrenders and fund withdrawals
in the retirement business declined $181 million mainly due to a decline between years in the level of large
withdrawals in the separate accounts by institutional investors. Partially offsetting the decline in separate
account withdrawals in the retirement business was an increase in traditional GIC withdrawals between periods.
In addition there was an increase of $166 million between years in the group insurance business primarily due to
an increase in surrenders and withdrawals.
Net (Decrease) Increase in Reserves
2009 to 2008 Three Month Comparison. Reserves increased $585 million for the three months ended March
31, 2009, compared to an increase of $1,043 million for the three months ended March 31, 2008. The decrease
of $458 million in the change in reserves between years was primarily due to a decrease of $564 million in the
retirement business mainly due to the increase in withdrawals of traditional GIC‘s as discussed under
―Benefits‖. Partially offsetting the decrease in reserves in the retirement business was an increase of $72 million
between years in the Group Insurance business primarily driven by increase in policy loans and growth in the
group life business.
Commissions
2009 to 2008 Three Month Comparison. Commissions decreased $6 million from $137 million for the three
months ended March 31, 2008 to $131 million for the three months ended March 31, 2009. The change
between years was primarily driven by a decline in sales of institutional investor products in the retirement
business.
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Other Expenses
2009 to 2008 Three Month Comparison. Other expenses increased $103 million from $30 million for the
three months ended March 31, 2008 to $133 million for the three months ended March 31, 2009. The increase
in other expenses was mostly due to reserve adjustments on reinsurance assumed related to the Allstate annuity
acquisition. These adjustments were mostly offset by net premiums, benefits, withdrawals and policyholder
dividends assumed as part of the reinsurance of the Allstate business.
.
Net Transfer (From) To Separate Accounts
2009 to 2008 Three Month Comparison. Net transfer from separate accounts were $1,129 million for the
three months ended March 31, 2009, compared to $1,351 million for the three months ended March 31, 2008.
The $222 million change between years was principally driven by a decline in surrenders and withdrawals in the
retirement business as previously discussed under ―Benefits‖.
Dividends to Policyholders
2009 to 2008 Three Month Comparison. Dividends to policyholders increased $58 million from $525
million for the three months ended March 31, 2008 to $583 million for the three months ended March 31, 2009.
The increase was primarily driven by changes in certain adjustments related to the reinsurance of the Closed
Block business, as discussed above under ―Revenues.‖ Partially offsetting the increase due to the reinsurance
related adjustments was a decrease in accrued policyholder dividends as a result of a lower dividend scale in the
current year.
Income Tax (Benefit) Provision
2009 to 2008 Three Month Comparison. The income tax (benefit) provision declined $165 million between
years from a provision of $45 million for the three months ended March 31, 2008 to a benefit of ($120) million
for the three months ended March 31, 2009. The decline in income taxes between years was primarily driven by
the following two items: (1) a decline in PICA‘s effective tax rate as a result of certain permanent adjustments in
the current period, principally the exclusion of the net gain resulting from the termination of funding agreements
previously issued by PICA to PFI as discussed above under "Net (Loss) Income," and the net benefit from the
release of liabilities previously provided for uncertain tax positions as a result of the settlement of an IRS
examination in 2009, including a decrease in interest expense accrued on uncertain tax positions.
Capital (Losses)
2009 to 2008 Three Month Comparison. Net realized capital (losses) after taxes and contribution to the
IMR, decreased $44 million, from net realized capital (losses) of $330 million for the three months ended March
31, 2008 to net realized capital (losses) of $286 million for the three months ended March 31, 2009. The
following table sets forth the components of net realized capital (losses):
Three Months Three Months
Ended
March 31,
Ended
March 31,
2009 2008 Change
($ in millions)
Bonds…………………….……………………………….. $ (204) $ (338) $ 134
Equity securities………………………………………….. (222) (92) (130)
Derivative instruments……………………………………. 315 103 212
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Other……………………………………………………… (63) 10 (73)
Gross realized capital (losses)………………….. (174) (317) 143
Less capital gains tax ………………….……………… 21 - 21
Less IMR transfers, net of tax…………………………….. 91 13 78
Net realized capital (losses)…..…………………… …... $ (286) $ (330) $ 44 (92)
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The change in net realized capital (losses) was driven by $534 million of other-than-temporary
impairments for the three months ended March 31, 2009. The other-than-temporary impairments for the three
months ended March 31, 2009 consisted of $303 million related to bonds, $230 million related to common stock
and $1 million related to preferred stocks. Partially offsetting these other-than-temporary impairments were
realized net gains in derivative instruments for the three months ended March 31, 2009. Other-than-temporary
impairments for the three months ended March 31, 2008 were $494 million and included $441 million related to
bonds and $51 million related to common stocks and $2 million related to preferred stock. Other-than-
temporary impairments recorded on bonds for the three months ended March 31, 2008 included $365 million
related to asset-backed securities collateralized by sub-prime mortgages. For a further discussion on other-than-
temporary impairments, see ―Impairments of Bonds‖ below.
Net unrealized capital losses increased $651 million for the three months ended March 31, 2009 compared
to an increase of $344 million for the three months ended March 31, 2008. The increase during the first quarter
of 2009 was primarily driven by unrealized losses on derivative instruments mainly due to realized net gains on
derivatives in the current period as discussed above. By realizing these gains, a corresponding offset to change
in unrealized capital (losses) occurs. Additionally, unrealized unaffiliated bond losses were $217 million for the
three months ended March 31, 2009. The unrealized losses on bonds resulted primarily from an increase in
NAIC 6 rated debt securities. Statutory accounting policy requires that NAIC 6 rated debt securities be recorded
at fair value. For further discussion on change in unrealized capital losses on bonds see ―Impairments of Bonds‖
below. Also, a decrease in affiliated common stocks contributed to the net unrealized capital losses during the
first quarter of 2009 primarily driven by a net loss in PICA‘s insurance subsidiary, PLI, mainly due to individual
annuity losses. Partially offsetting these unrealized losses was the tax benefit related to unrealized (losses). The
unrealized capital (losses) in 2008 were principally driven by unrealized losses on common stock and other
invested assets mainly as a result of equity market declines.
Investment Results
Summary of Investments
PICA's general account investment portfolio consists of public and private bonds, mortgage loans, equity
securities, contract loans, real estate and other invested assets. The composition of PICA's portfolio reflects,
within the discipline provided by its risk management approach, its need for competitive results and the
selection of diverse investment alternatives available primarily through its Investment Manager. The size of
PICA's portfolio enables it to invest in asset classes that may be unavailable to the typical investor.
The following table sets forth the composition of PICA's invested assets as of the dates indicated in
accordance with SAP.
March 31, 2009 December 31, 2008
Carrying % of Carrying % of
Amount Total Amount Total
($ in millions)
Long-term bonds
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Public bonds $65,242 45.9 % $65,617 45.2 %
Private bonds 32,783 23.1 32,410 22.4
Preferred stock 339 0.2 695 0.5
Common stock 6,481 4.6 6,673 4.6
Mortgage loans 19,889 14.0 20,173 13.9
Real estate 320 0.2 317 0.2
Contract loans 6,846 4.8 6,777 4.7
Cash and short-term investments 5,560 3.9 7,883 5.4
Joint ventures and limited partnerships 2,993 2.1 2,957 2.0
Receivables for securities 379 0.3 137 0.1
Aggregate write-ins 1,201 0.9 1,387 1.0
Total invested assets $142,033 100.0 % $145,026 100.0 %
The overall income yield on PICA's invested assets after investment expenses, but excluding net realized
investment gains (losses) and IMR amortization, was 5.22% for the three months ended March 31, 2009, versus
4.90% for the three months ended March 31, 2008. The increase in the yield between periods was mainly due to
a decline in investment expenses, primarily the result of lower interest expense on borrowed money, partially
offset by a decrease in fixed maturity yields as a result of lower interest rates on floating rate investments due to
rate resets. The following table sets forth the income yield and investment income, excluding realized
investment gains (losses) and IMR amortization, for each of PICA‘s major asset categories for the periods
indicated.
Quarter Ended
March 31, 2009 March 31, 2008
Yield Amount Yield Amount
($ in millions)
Long-term bonds 5.88 % 1,431 6.06 % $1,539
Stocks 3.91 69 1.43 31
Mortgage loans 6.08 302 6.24 292
Contract loans 6.11 103 5.97 102
Cash and short-term investments 2.03 34 5.08 72
Other investments 6.06 73 4.38 57
Total before investment expenses 5.65 $2,012 5.70 $2,093
Total after investment expenses 5.22 % $1,862 4.90 % $1,801
Bonds
PICA held 69% of its invested general account assets in bonds as of March 31, 2009, compared to 68% at
December 31, 2008. These securities included both publicly traded and privately placed debt securities
representing an array of industry categories.
PICA manages its public portfolio to a risk profile directed by the Asset Liability Management and Risk
Management groups. PICA seeks to employ relative value analysis both in credit selection and in purchasing
and selling securities. The total return that it earns on the portfolio is reflected both as investment income and
also as realized gains or losses on investments.
PICA uses its private placement and asset-backed portfolios to enhance the diversification and yield of its
overall bond portfolio. Over the last several years, the Investment Manager's investment staff has directly
originated more than half of PICA's annual private placement originations. The Investment Manager's
origination capability provides it with the opportunity to lead transactions and obtain better terms, such as
covenants and call protection, and to take advantage of innovative transaction structures.
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The following table sets forth the composition of PICA's long-term bond portfolio by industry category as of
the dates indicated.
March 31, 2009 December 31, 2008
% of Estimated % of Estimated
Amortized Total Fair Amortized Total Fair
Cost Cost Value Cost Cost Value
($ in millions)
US governments $4,463 4.6 % $5,123 $4,354 4.4 % $5,399
All other governments 1,625 1.7 1,826 1,738 1.8 2,003
Political subdivisions of states, territories, & possessions 0.0 0.0
(direct & guaranteed)
Special revenue & special assessment obligations & 6,783 6.9 7,245 7,265 7.4 7,741
non guaranteed obligations of agencies
Public utilities 7,200 7.3 6,822 7,333 7.5 6,962
Industrial & miscellaneous (unaffiliated) 73,829 75.3 62,693 72,213 73.7 61,504
Credit tenant loans (unaffiliated) 59 0.1 61 60 0.1 62
Parent, subsidiaries and affiliates 4,066 4.1 4,002 5,064 5.1 5,139
Total long-term bonds $98,025 100.0 % $87,772 $98,027 100.0 % $88,810
As of March 31, 2009, Industrial & miscellaneous (unaffiliated) included approximately $8.8 billion ($4.9
billion fair value) of securities collateralized by sub-prime mortgages. While there is no market standard
definition, we define sub-prime mortgages as residential mortgages that are originated to weaker quality
obligors as indicated by weaker credit scores, as well as mortgages with higher loan to value ratios, or limited
documentation. The significant deterioration of the U.S. housing market, high interest rate resets, and relaxed
underwriting standards for some originators of sub-prime mortgages have led to higher delinquency rates,
particularly for those mortgages issued in 2006 and 2007. The following table sets forth the composition of our
asset-backed securities as of March 31, 2009 by credit quality, and for asset-backed securities collateralized by
sub-prime mortgages, by year of issuance (vintage).
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__________ (1) Our enhanced short-term portfolio is used primarily to invest cash proceeds of securities lending and repurchase activities, and cash generated from
certain trading and operating activities. The investment policy statement of this portfolio requires that securities purchased for this portfolio have a remaining expected average life of 2 years or less when acquired.
The table above provides ratings assigned by nationally recognized rating agencies, as of March 31, 2009,
and reflect credit rating downgrades on asset-backed securities collateralized by sub-prime mortgages processed
by the rating agencies in 2009. The following tables set forth the percentage, based on amortized cost, of our
asset-backed securities collateralized by sub-prime mortgages attributable to the Financial Services Businesses
by lowest rating agency rating, as of the dates indicated.
Asset-Backed Securities Collateralized by Sub-prime Mortgages Lowest Rating Agency Rating
AAA AA A BBB
BB and
below
December 31, 2008 24 % 23 % 12 % 20 % 21 %
March 31, 2009 8 % 19 % 13 % 16 % 44 %
In making our investment decisions, rather than relying solely on the rating agencies‘ evaluations, PICA
assigns internal ratings to our asset-backed securities based upon our dedicated asset-backed securities unit‘s
independent evaluation of the underlying collateral and securitization structure, including any guarantees from
monoline bond insurers. The $8.8 billion ($4.9 billion fair value) of asset-backed securities collateralized by
sub-prime mortgages as of March 31, 2009 represents a $0.8 billion decrease from $9.6 billion as of December
31, 2008, primarily reflecting principal paydowns and other-than-temporary impairments recognized.
As of March 31, 2009, Industrial & miscellaneous (unaffiliated) included approximately $0.8 billion ($0.4
billion fair value) of externally managed investments in the European market. At December 31, 2008,
externally managed investments in the European market were approximately $0.8 billion ($0.5 billion fair
value). The externally managed investments in European markets, included in the above table, reflects PICA‘s
March 31, 2009
Lowest Rating Agency Rating
Vintage AAA AA A BBB
BB and
below
Total
Amortized
Cost
Total
Fair
Value
($ in millions)
Collateralized by sub-prime mortgages:
Enhanced short-term portfolio (1)
2009 .............................................................. $ $
$ $ $ $ $ 2008 .............................................................. 2007 .............................................................. 86 14 35 30 702 867 524 2006 .............................................................. 324 386 233 472 993 2,408 1,808
2005 .............................................................. 33 1 19 53 43
2004 & Prior ................................................. Total enhanced short-term portfolio .................... 443 400 269 502 1,714 3,328 2,375
All other portfolios
2009 .............................................................. 2008 .............................................................. 2007 .............................................................. 31 18 393 442 179
2006 .............................................................. 153 103 168 383 1,416 2,223 928 2005 .............................................................. 21 262 232 204 237 956 448
2004 & Prior ................................................. 95 899 430 272 144 1,840 955
Total all other portfolios ................................... 300 1,282 830 859 2,190 5,461 2,510
Total collateralized by sub-prime mortgages ....... 743 1,682 1,099 1,361 3,904 8,789 4,885 Other asset-backed securities:
Collateralized by auto loans .............................. 738 64 7 99 9 917 876
Collateralized by credit cards ............................ 186 1,029 1,215 845 Externally managed investments in the
European market 206 581 787 411
Other asset-backed securities ............................ 767 85 81 112 133 1,178 985
Total asset-backed securities ....................... $ 2,434 $ 1,831 $ 1,393 $ 3,182 $ 4,046 $ 12,886 $ 8,002
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investment in medium term notes that are collateralized by portfolios of assets primarily consisting of European
fixed income securities, including corporate bonds and asset-backed securities as well as derivatives. As of
March 31, 2009 none of the underlying investments were securities collateralized by U.S. sub-prime mortgages,
and most of the underlying investments were rated investment grade.
As of March 31, 2009, Industrial & miscellaneous (unaffiliated) included $7.4 billion ($6.3 billion fair
value) of commercial mortgage-backed securities. At December 31, 2008, commercial mortgage-backed
securities were $7.5 billion ($6.2 billion fair value). Weakness in commercial real estate fundamentals, along
with a decrease in the overall liquidity and availability of capital have led to a very difficult refinancing
environment and an increase in the overall delinquency rate on commercial mortgages in the commercial
mortgage-backed securities market. Difficult conditions in the global financial markets and the overall economic
downturn continue to put additional pressure on these fundamentals through rising vacancies, falling rents and
falling property values. In addition, we have recognized several market factors related to commercial mortgage-
backed securities issued in 2006 and 2007, including less stringent loan underwriting, higher levels of leverage
and collateral valuations that are generally no longer realizable. To ensure our investment objectives and asset
strategies are maintained, we consider these market factors in making our investment decisions on securities in
these vintages. The following table sets forth the composition of our commercial mortgage-backed securities as
of March 31, 2009 by credit quality and by the year of issuance (vintage).
As of March 31, 2009, based on amortized cost, approximately 95% of the commercial mortgage-backed
securities attributable to PICA have estimated credit subordination percentages of 20% or more, and 70% have
estimated credit subordination percentages of 30% or more. The subordination percentage represents the current
weighted average estimated percentage of the capital structure subordinated to our investment holding that is
available to absorb losses before the security incurs the first dollar loss of principal. The estimated
subordination percentage includes an adjustment for that portion of the capital structure that has been effectively
defeased by US Treasury securities.
Commercial Mortgage-Backed Securities -Subordination Percentages by Rating and Vintage March 31, 2009
Lowest Rating Agency Rating
Vintage AAA AA A BBB
BB and
below
2009 ............................................................. — % — % — % — % — % 2008 ............................................................. 28 — — — —
2007 ............................................................. 29 — — — —
2006 ............................................................. 30 — — — — 2005 ............................................................. 28 — — — —
2004 & Prior ................................................ 35 24 30 26 21
The following table sets forth the amortized cost of our AAA commercial mortgage-backed securities as of
the dates indicated, by type and by year of issuance (vintage).
March 31, 2009
Lowest Rating Agency Rating
Vintage AAA AA A BBB
BB and
below
Total
Amortized
Cost
Total
Fair
Value
($ in millions)
2009 .............................................................. $ $ $ $ $ $ $ 2008 .............................................................. 10 10 8
2007 .............................................................. 970 19 989 774
2006 .............................................................. 2,582 2,582 2,094
2005 .............................................................. 1,906 1,906 1,619
2004 & prior .................................................. 1,733 98 57 8 4 1,900 1,759
Total commercial mortgage backed
securities .............................................. $
7,201 $ 98 $ 76 $ 8 $ 4 $ 7,387 $ 6,254
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AAA Rated Commercial Mortgage-Backed Securities – Amortized Cost by Type and Vintage
March 31, 2009
Super Senior AAA Structures Other AAA Structures
Vintage
Super
Senior
(shorter
duration
tranches)
Super
Senior
(longest
duration
tranche) Mezzanine Junior
Other
Senior
Other
Subordinate
Other
Total AAA
Securities at
Amortized
Cost
(in millions)
2009 .............................................................. $ — $ — $ — $ — $ — $ — $ — $ — 2008 .............................................................. 10 — — — — — — 10 2007 .............................................................. 945 25 — — — — — 970
2006 .............................................................. 1,804 748 — — — — 30 2,582 2005 .............................................................. 1,404 485 — — — — 17 1,906 2004 & Prior ................................................. 81 27 — — 1,296 3102 19 1,733
Total ..................................................... $ 4,244 $ 1,285 $ — $ — $ 1,296 $ 310 $ 66 $ 7,201
Certain of PICA‘s bonds are supported by guarantees from monoline bond insurers. As of March 31,
2009, $1.5 billion, or 2%, of general account bonds were supported by guarantees from monoline bond insurers.
At December 31, 2008, $1.7 billion, or 2% of the general account bonds were supported by guarantees from
monoline bond insurers. As of March 31, 2009, 31% of these investments had A credit ratings or higher,
reflecting the credit quality of the monoline bond insurers. Management estimates, taking into account the
structure and credit quality of the underlying investments and giving no effect to the support of these securities
by guarantees from monoline bond insurers, that 42% of the $1.5 billion would have investment grade credit
ratings. Additionally, $1.1 billion of the $1.5 billion of securities supported by bond insurance were asset-
backed securities collateralized by sub-prime mortgages, $0.2 billion were other asset-backed securities and $0.2
billion were municipal bonds. Management estimates that 24% of the asset-backed securities collateralized by
sub-prime mortgages, 75% of the other asset-backed securities, and all of the municipal bonds would have
investment grade credit ratings giving no effect to the support of these securities by guarantees from monoline
bond insurers. As of March 31, 2009, the bond insurance is provided by five insurance companies, with no
company representing more than 36% of the overall amortized cost of the securities supported by bond
insurance.
The following table sets forth the amortized cost and fair value of our fixed maturity investments supported
by guarantees from monoline bond insurers as of March 31, 2009.
March 31, 2009
($ in millions)
Amortized
Cost
Fair
Value
Fixed maturities guaranteed by monoline bond insurers Asset-backed securities:
Collateralized by sub-prime mortgages $ 1,057 $ 650
Other 217 171
Total asset-backed securities 1,274 821
Municipal bonds 211 218
Total $ 1,485 $ 1,039
The SVO of the NAIC evaluates the investments of insurers for regulatory reporting purposes and assigns
bonds to one of six categories called "NAIC Designations." NAIC designations of "1" or "2" include bonds
considered investment grade, which include securities rated Baa3 or higher by Moody's or BBB- or higher by
S&P. NAIC Designations of "3" through "6" are referred to as below investment grade, which include securities
rated Ba1 or lower by Moody's and BB+ or lower by S&P. As a result of time lags between the funding of
investments, the finalization of legal documents, and the completion of the SVO filing process, the bond
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portfolio generally includes securities that have not yet been rated by the SVO as of each balance sheet date.
Pending receipt of SVO ratings, the categorization of these securities by NAIC designation is based on the
expected ratings indicated by internal analysis.
The fair values of public bonds are based on quoted market prices or prices obtained from independent
pricing services. In order to validate reasonability, prices are obtained from multiple independent services where
available and are also reviewed by our internal asset managers through comparison with directly observed recent
market trades or comparison of all significant inputs used by the pricing service to our observations of those
inputs in the market. For investments in private bonds, this information is not available. For these private
bonds, the fair value is determined typically by using a discounted cash flow model, which relies upon the
average of spread surveys collected from private market intermediaries who are active in both primary and
secondary transactions and takes into account, among other factors, the credit quality of the issuer and the
reduced liquidity associated with private bonds. In determining the fair value of certain bonds, the discounted
cash flow model may also use unobservable inputs, which reflect PICA‘s own assumptions about the inputs
market participants would use in pricing the asset.
The following tables set forth PICA's public and private bond portfolios by NAIC rating as of the dates
indicated.
Public Bonds by Credit Quality
March 31, 2009 December 31, 2008
Rating % of Estimated % of Estimated
NAIC Agency Amortized Total Fair Amortized Total Fair
Rating Equivalent Cost Cost Value Cost Cost Value
($ in millions)
1 Aaa, Aa, A $41,233 63.2 % $38,989 $42,697 65.1 % $40,894
2 Baa 15,534 23.8 12,852 15,901 24.2 13,255
Subtotal Investment Grade $56,767 87.0 $51,841 $58,598 89.3 $54,149
3 Ba 4,389 6.7 3,416 4,059 6.2 3,027
4 B 2,874 4.4 1,800 2,292 3.5 1,484
5 C and lower 1,072 1.7 564 624 0.9 435
6 In or near default 140 0.2 151 44 0.1 47
Subtotal Below Investment Grade $8,475 13.0 % $5,931 $7,019 10.7 % $4,993
Total $65,242 100.0 % $57,772 $65,617 100.0 % $59,142
Private Bonds by Credit Quality
March 31, 2009 December 31, 2008
Rating % of Estimated % of Estimated
NAIC Agency Amortized Total Fair Amortized Total Fair
Rating Equivalent Cost Cost Value Cost Cost Value
($ in millions)
1 Aaa, Aa, A $11,063 33.7 % $10,517 $10,705 33.0 % $10,299
2 Baa 15,906 48.5 14,556 15,653 48.3 14,305
Subtotal Investment Grade $26,969 82.2 $25,073 $26,358 81.3 $ 24,604
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3 Ba 3,545 10.8 3,061 3,681 11.4 3,120
4 B 1,484 4.6 1,193 1,536 4.7 1,193
5 C and lower 456 1.4 333 418 1.3 326
6 In or near default 329 1.0 340 417 1.3 425
Subtotal Below Investment Grade $5,814 17.8 % $4,927 $6,052 18.7 % $ 5,064
Total $32,783 100.0 % $30,000 $32,410 100.0 % $29,668668
The amortized cost of PICA's below-investment grade bonds as of March 31, 2009 totaled $14.3 billion, or
14.6% of amortized cost of total bonds, compared to $13.1 billion, or 13.3% of total bonds, as of December 31,
2008.
PICA maintains separate monitoring processes for public and private bonds and creates watch lists to
highlight bonds that require special scrutiny and management. The public bond asset managers formally review
all public bond holdings on a quarterly basis, and more frequently when necessary, to identify potential credit
deterioration, whether due to ratings downgrades, unexpected price variances, and/or industry specific concerns.
For private placements, the Investment Manager's credit and portfolio management processes help ensure
prudent controls over valuation and management. The Investment Manager uses separate pricing and
authorization processes to establish "checks and balances" for new investments. The Investment Manager
applies consistent standards of credit analysis and due diligence for all transactions, whether they originate
through its own in-house origination staff or through agents. The Investment Manager's regional offices closely
monitor the portfolios in their regions. The Investment Manager sets all valuation standards centrally and
assesses the fair value of all investments quarterly.
Impairments of Bonds
All bonds with unrealized losses are subject to review to identify other-than-temporary impairments in value.
In evaluating whether a decline in value is other-than-temporary, PICA considers several factors including, but
not limited to the following:
the reasons for the decline in value (credit event, currency or interest rate related, including general
spread widening);
PICA's ability and intent to hold its investment for a period of time to allow for recovery of value;
PICA's intent to sell its investment before recovery of the cost of the investment;
the financial condition of and near-term prospects of the issuer; and the extent and the duration of the
decline.
In the second quarter of 2008, effective January 1, 2008, PICA, for its statutory reporting, implemented the
guidance as outlined in Interpretation 06-07 in the Statutory Accounting Practices & Procedures Manual for
evaluating interest related other-than-temporary impairments. Under statutory accounting, the term "interest
related" includes a declining value due to both increases in the risk free interest rate and general credit spread
widening. An interest related impairment is deemed other-than-temporary when PICA has the intent to sell an
investment, at the reporting date, before recovery of the cost of the investment. An interest related decline
where PICA does not have the intent to sell is deemed temporary and an impairment is not recorded.
Previously, for statutory accounting and reporting, PICA followed its GAAP other-than-temporary impairment
policy for evaluating bond other-than-temporary impairments, under which impairments were generally not
differentiated between interest related and non-interest related. By making the change to follow statutory
accounting principles for evaluating interest-related bond impairments, other-than-temporary interest-related
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bond impairments previously recorded by PICA during the first quarter of 2008 were reduced by $131 million in
its financial statements as of second quarter 2008. This adjustment has not been retroactively reflected in the
first quarter 2008 results in the accompanying ―Statutory Statements of Operations and Changes in Capital and
Surplus‖. Prior to 2008, the impact of differences in statutory accounting principles and PICA's GAAP
impairment policies were considered immaterial on PICA's financial results.
Effective January 1, 2008, PICA voluntarily early adopted SSAP No. 98 ―Treatment of Cash Flows When
Quantifying Changes in Valuation and Impairments, an Amendment to SSAP No. 43" ("SSAP No. 98"). At the
time PICA voluntarily early adopted SSAP No. 98, SSAP No. 98 had a required adoption date of January 1,
2009. On April 17, 2009, the NAIC deferred the mandatory implementation date of SSAP No. 98 to periods
ending on or after September 30, 2009. The deferral of SSAP No. 98 does not address the accounting by
companies that early adopted SSAP No. 98. In light of the deferral of the mandatory adoption date, PICA
modified its impairment policy, on a prospective basis beginning in the first quarter of 2009, to follow the
guidance of SSAP No. 43 "Loan-backed and Structured Securities," which continues to apply, prior to the
adoption of SSAP No. 98.
Under SSAP No. 43, an other-than-temporary impairment has occurred when the undiscounted future cash
flow value of the security is less than the cost basis, at which point the cost basis of the security is written down
to the undiscounted future cash flow value, with no provision for recording interest-related other-than-temporary
impairments to the IMR. SSAP No. 98 required that, upon the determination that an other-than-temporary
impairment has occurred, the cost basis of the security should be written down to fair value. SSAP No. 98 also
provided that credit related other-than-temporary losses should be recorded to Realized Gains (losses) with an
adjustment to the AVR while interest related other-than-temporary losses should be applied directly to the IMR.
Application of SSAP No. 43 for the three months ended March 31, 2009 resulted in other-than-temporary
impairments, recorded to Realized Gains (Losses), on loan-backed and structured securities held at March 31,
2009 of $43 million, which would have been approximately $1.2 billion higher under the application of SSAP
No. 98. However, changes in unrealized losses would have been $0.2 billion lower under the application of
SSAP No. 98. While management believes SSAP No. 98 will be modified or further deferred, absent such a
change or further deferral of the mandatory adoption of SSAP No. 98 for periods ending on or after September
30, 2009 or other regulatory developments, or absent PICA requesting and obtaining a specific permitted
practice from the New Jersey Department of Banking and Insurance (―NJDOBI‖), PICA would recognize this
incremental amount of other-than temporary impairments related to these securities in its results and surplus for
the nine months ended September 30, 2009.
Unrealized Losses from Bonds
The following table sets forth the amortized cost and gross unrealized losses of bonds where the estimated
fair value has declined below amortized cost by 20% or more as of the dates indicated:
Bonds March 31, 2009 December 31, 2008
Gross Gross
Amortized Unrealized Amortized Unrealized
Cost Losses Cost Losses
($ in millions)
Less than three months $4,718 $1,280 $6,542 $1,725
Three months or greater but less than six months 4,830 1,465 12,427 4,378
Six months or greater but less than nine months 10,034 4,141 1,711 831
A-16
Nine months or greater but less than twelve months 1,638 911 1,627 944
Greater than twelve months 1,823 1,229 859 544
Total $23,043 $9,026 $23,166 $8,422
Gross unrealized losses were primarily concentrated in the asset backed, manufacturing, and finance
sectors as of March 31, 2009 and in asset backed, manufacturing, and commercial mortgage backed sectors as of
December 31, 2008. Gross unrealized losses where the estimated fair value had declined and remained below
amortized cost by 20% or more of $9.026 billion as of March 31, 2009 includes $3.887 billion relating to asset-
backed securities collateralized by sub-prime mortgages. Included within gross unrealized losses are losses
related to leveraged lease transactions, a majority of which includes the deferred tax liability related to these
transactions, which is presented separately in the balance sheet. Unrealized losses on leveraged lease
transactions were $167 million as of March 31, 2009 and $159 million as of December 31, 2008. PICA has not
recognized the gross unrealized losses shown in the tables above as other-than-temporary impairments.
Preferred Stock
PICA held less than 1% of its invested general account assets in preferred stock as of both March 31, 2009
and December 31, 2008.
Common Stocks
PICA held 5% of its invested general account assets in common stock as of both March 31, 2009 and
December 31, 2008. Substantially all of PICA's unaffiliated common stocks are publicly traded on national
securities exchanges.
Impairments of Common Stocks
Common stocks with unrealized losses are subject to review to identify other-than-temporary impairments in
value. In evaluating whether a decline in value is other-than-temporary, PICA considers several factors
including, but not limited to, the following:
• the extent and the duration of the decline, including, but not limited to, the following general
guidelines:
o declines in value greater than 20%, maintained for six months or greater;
o declines in value maintained for one year or greater; and
o declines in value greater than 50%;
• the reasons for the decline in value (credit event, currency or market fluctuation);
• PICA‘s ability and intent to hold the investment for a period of time to allow for a recovery of value,
including common stock managed by independent third parties where we do not have management
discretion; and
• the financial condition of and near-term prospects of the issuer.
When it has been determined that there is an other-than-temporary impairment, PICA records a write down in
its Statement of Operations and Changes in Capital and Surplus within "Net Realized Capital Gains (Losses)" to
the estimated fair value, which reduces the cost basis. The new cost basis of an impaired security is not adjusted
for subsequent increases in estimated fair value. Estimated fair values for publicly traded common stock are
based on quoted market prices or prices obtained from independent pricing services. Estimated fair values for
A-17
privately traded common stock are determined using valuation and discounted cash flow models that require a
substantial level of judgment.
Unrealized Losses from Common Stocks
The following table sets forth the cost and gross unrealized losses of common stocks in unaffiliated entities
where the estimated fair value has declined and remained below cost by less than 20% as of the dates indicated:
Common Stock March 31, 2009 December 31, 2008
Gross Gross
Unrealized Unrealized
Cost Losses Cost Losses
($ in millions)
Less than three months $139 $10 $135 $9
Three months or greater but less than six months 207 19 399 43
Six months or greater but less than nine months 207 24 38 5
Nine months or greater but less than twelve months 16 2 25 2
Greater than twelve months 52 6 3 1
Total $621 $61 $600 $60
The following table sets forth the cost and gross unrealized losses of common stocks in unaffiliated entities
where the estimated fair value has declined and remained below cost by 20% or more as of the dates indicated:
Common Stock March 31, 2009 December 31, 2008
Gross Gross
Unrealized Unrealized
Cost Losses Cost Losses
($ in millions)
Less than three months $304 $95 $250 $73
Three months or greater but less than six months 376 153 1,124 490
Six months or greater but less than nine months 871 407 97 50
Nine months or greater but less than twelve months 44 17 19 11
Greater than twelve months 7 3 1 1
Total $1,602 $675 $1,491 $625
Gross unrealized losses as of March 31, 2009 and December 31, 2008 were primarily concentrated in the
manufacturing, finance and service sectors.
Also included in change in unrealized losses in common stocks for the three months ended March 31, 2009
are affiliated losses of $59 million primarily driven by $105 million of losses in PICA‘s insurance subsidiary,
PLI, partially offset by gains in other non-insurance subsidiaries.
Mortgage Loans
PICA held 14% of its invested general account assets in mortgage loans, as of both March 31, 2009 and
December 31, 2008. The portfolio as of March 31, 2009 consisted of 1,216 commercial mortgage loans with an
aggregate carrying value of $18.2 billion and 913 residential and agricultural loans with an aggregate carrying
value of $1.7 billion.
A-18
The Investment Manager originates commercial mortgages using dedicated investment staff and a network of
independent companies through various regional offices across the country. All commercial mortgage loans are
underwritten consistently with PICA's standards using a proprietary quality rating system that has been
developed using the Investment Manager's experience in commercial real estate and mortgage lending. The loan
portfolio strategy emphasizes diversification by property type and geographic location.
The following table sets forth the breakdown of the mortgage loan portfolio by geographic region as of the
dates indicated.
March 31, 2009 December 31, 2008
Carrying % of Carrying % of
U.S. Regions: Value Total Value Total
($ in millions)
Pacific $6,505 32.7 % $6,661 33.0 %
South Atlantic 4,263 21.4 4,435 22.0
Middle Atlantic 3,296 16.6 3,409 16.9
West South Central 1,373 6.9 1,370 6.8
East North Central 1,367 6.9 1,381 6.9
Mountain 1,064 5.3 995 4.9
New England 790 4.0 793 3.9
West North Central 536 2.7 508 2.5
East South Central 360 1.8 367 1.8
Subtotal – U.S. Regions $19,554 98.3 % $19,919 98.7 %
Other 335 1.7 254 1.3
Total mortgage loans $19,889 100.0 % $20,173 100.0 %
Of the mortgage loan portfolio as of March 31, 2009, the states with the most significant concentrations of
mortgage loans were California and New York, with $5.2 billion and $2.0 billion, respectively.
The stress experienced in the global financial markets and unfavorable credit market conditions that began in
the second half of 2007 and continued and substantially increased throughout 2008 and into 2009 led to a
decrease in the overall liquidity and availability of capital in the commercial mortgage loan market, and in
particular a decrease in activity by securitization lenders. These conditions have led to greater opportunities for
more selective originations by portfolio lenders such as our general account. While we have begun to observe
some weakness in commercial real estate fundamentals, delinquency rates on our commercial mortgage loans
have been relatively stable in recent years. However, continued difficult conditions in the global financial
markets and the overall economic downturn could put additional pressure on these fundamentals through rising
vacancies, falling rents and falling property values. As of March 31, 2009, our general account investments in
commercial mortgage loans attributable to the Financial Services Businesses had an average debt service
coverage ratio of 1.92 times, and an average loan-to-value ratio of 57%.
The following table sets forth the amortized cost of investments in mortgage loans as of March 31, 2009 by
loan to value and debt service coverage ratios.
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March 31, 2009
Debt Service Coverage Ratio (1)
Greater
than 2.0x
1.8x to
2.0x
1.5x to
1.8x
1.2x to
1.5x
1.0x to
1.2x
Less than
1.0x
Total
Mortgage
Loans
% of
Total
Mortgage
Loans
Loan to Value Ratio (in millions)
0% - 50% ................................................... $ 4,290 821 1,142 856 122 125 7,356 37.0%
50% - 60% ................................................. 795 546 1,062 451 218 115 3,187 16.0
60% - 70% ................................................. 635 466 1,318 1,582 213 — 4,214 21.2
70% - 80% ................................................. 140 476 582 1,007 422 109 2,736 13.7
80% - 90% ................................................. 20 21 268 1,003 267 37 1,616 8.1
90% - 100% ............................................... 164 — 29 95 175 6 469 2.4
Greater than 100% ..................................... — 33 — — 191 87 311 1.6
Total mortgage loans .................................. $ 6,044 2,363 4,401 4,994 1,608 479 19,889 100.0%
Percentage of total
mortgages .................................................... 30.4 11.9 22.1 25.1 8.1 2.4
100.0%
_________ (1) The majority of the collateral values used in the calculation of the loan-to-value ratios are based upon the appraised value of the property at the time of
loan origination.
The following table sets forth the breakdown of our mortgage loan portfolio by year of origination as of
March 31, 2009.
March 31, 2009
Year of Origination
Gross
Carrying
Value
% of Total
($ in millions)
2009 $225 1.1 % 2008 3,332 16.8
2007 4,750 23.9
2006 3,202 16.1 2005 1,997 10.0
2004 and prior 6,383 32.1
Total collateralized loans $19,889 100.0 %
The Investment Manager performs ongoing surveillance of the portfolio and places loans on watch list status
based on a predefined set of criteria. Loans are placed on early warning status in cases where the Investment
Manager detects that the physical condition of the property, the financial situation of the borrower or tenant, or
other market factors could lead to a loss of principal or interest. Loans are classified as closely monitored when
there is a collateral deficiency or other credit events that may lead to a potential loss of principal or interest.
Loans not in good standing are those loans where there is a high probability of loss of principal, such as when
the loan is in the process of foreclosure or the borrower is in bankruptcy. Workout and special servicing
professionals manage the loans on the watch list.
The following table shows the respective amounts of PICA's mortgage loan portfolio that are in good
standing, are in good standing with restructured terms, have interest overdue more than three months but are not
in foreclosure, and are in the process of foreclosure, as of the dates indicated.
March 31, December 31,
2009 2008
Carrying Carrying
Value Value
($ in millions)
A-20
Good standing $19,887 $20,168
Good standing with restructured terms 1 2
Interest overdue more than three months, not in foreclosure 1 3
Foreclosure in process — —
Total mortgage loans $19,889 $20,173
Joint Ventures and Limited Partnerships
PICA's investments in joint ventures and limited partnerships were $3.0 billion as of both March 31, 2009
and December 31, 2008. The following table sets forth the composition of PICA's joint ventures and limited
partnerships by type, as of the dates indicated.
March 31, 2009 December 31, 2008
Carrying % of Carrying % of
Value Total Value Total
($ in millions)
Joint venture and Limited partnership interests in real estate $388 13.0 % $411 13.9 %
Joint venture and Limited partnership interests in common stock 1,024 34.2 954 32.2
Joint venture and Limited partnership interests in fixed income 662 22.1 706 23.9
Joint venture and Limited partnership interests - other 919 30.7 886 30.0
Total joint ventures and limited partnerships $2,993 100.0 % $2,957 100.0 %
Government Sponsored Entities
Our exposure to Fannie Mae and Freddie Mac includes investments in short-term and long-term debt
securities issued by these government sponsored entities as well as investments in residential mortgage-backed
securities supported by guarantees from these government sponsored entities. During the third quarter of 2008
Fannie Mae and Freddie Mac were placed into U.S. government conservatorship. The following table sets forth
the amortized cost and fair value of our investments in short-term and long-term debt securities issued by these
government sponsored entities as of the date indicated.
March 31, 2009
Amortized Cost Fair Value
($ in millions)
Short-term debt securities ....................................................................................... $ 735 $ 735
Long-term debt securities ........................................................................................ 556 645
Total investment in debt securities issued by government sponsored
entities ................................................................................................................... $ 1,291 $ 1,380
As of March 31, 2009, long-term bonds attributable to PICA include $5.6 billion of publicly traded pass-
through securities with guarantees from Fannie Mae or Freddie Mac and AAA credit ratings.
Liquidity and Capital Resources
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Liquidity
PICA's principal cash flow sources from insurance, annuities and guaranteed products are premiums and
annuity considerations, investment and fee income, and investment maturities and sales. PICA supplements
these cash inflows with financing activities. PICA‘s cash outflow requirements principally relate to benefits,
claims, dividends paid to policyholders, and payments to contract holders in connection with surrenders,
withdrawals and net policy loan activity. Benefits include the payment of benefits under life insurance, annuity
and guaranteed products. PICA‘s uses of cash also include commissions, general and administrative expenses,
purchases of investments, and debt service and repayments in connection with financing activities, as well as
dividend payments to its parent, PH.
Some of PICA's products, such as guaranteed products offered to institutional customers, provide for
payment of accumulated funds to the contract holder at a specified maturity date unless the contract holder
elects to roll over the funds into another contract with PICA. PICA regularly monitors its liquidity requirements
associated with policyholder and contract holder obligations so that it can manage cash inflows to match
anticipated cash outflow requirements.
In addition, PICA has several subsidiaries that are subject to regulatory limitations on the payment of
dividends to PICA.
The liquidity of PICA's operations is also related to the overall quality of its investments and its asset-
liability management.
PICA is subject to regulatory limitations on the payment of dividends. New Jersey insurance law provides
that, except in the case of extraordinary dividends or distributions, all dividends or distributions declared or paid
by PICA may be declared or paid from unassigned surplus, as determined pursuant to SAP, less unrealized
capital gains and revaluation of assets. PICA must notify the Commissioner of its intent to pay a dividend. If the
dividend, together with other dividends or distributions made within the preceding twelve months, would exceed
a specified statutory limit, PICA must also obtain the prior non-disapproval of the Commissioner.
The current statutory limitation applicable to New Jersey life insurers for ordinary dividends generally is the
greater of 10% of the prior calendar year‘s statutory surplus or the prior calendar year‘s statutory net gain from
operations (excluding realized capital gains).
Moreover, the Commissioner is authorized to disallow the payment of any dividend or distribution that
would otherwise be permitted under the statutory limit set forth above if it determines that a company does not
have a reasonable surplus as to policyholders relative to its outstanding liabilities and adequate to its financial
needs or if it finds such company to be in a hazardous financial condition. In addition to these regulatory
limitations, the terms of the IHC debt also contain restrictions potentially limiting dividends by PICA applicable
in the event the Closed Block business is in financial distress and other circumstances that may be paid by
PICA.
During the fourth quarter of 2008, PFI contributed PSG Holdings, LLC, valued at approximately $2.2
billion, to PICA as a capital contribution. PSG Holdings, LLC owns PICA's joint venture interest in Wachovia
Securities Financial Holdings, LLC, as well as other wholly owned businesses, principally the global
commodities group.
On December 4, 2008, PFI announced its intention to exercise its right under a "lookback" option to put its
joint venture interest in Wachovia Securities Financial Holdings, LLC to Wells Fargo & Co. which completed
its merger with Wachovia Corporation on December 31, 2008. Under the terms of the joint venture agreements,
PICA management expects closing of the put transaction would occur on or about January 1, 2010. The full
value PICA expects to receive related to the ―lookback‖ option is not yet reflected in PICA‘s capital levels as
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the investment is carried at book value. Under the terms of the joint venture agreements, Wells Fargo may elect
to pay the proceeds from exercise of the ―lookback‖ put either in cash, Wells Fargo common stock or a
combination of the foregoing.
PICA estimates the proceeds from the exercise of the ―lookback‖ put to be approximately $5 billion, based
on a January 1, 2010 closing, the terms of the joint venture agreements and PICA‘s assessment of market
conditions and retail brokerage firm valuations at the relevant valuation date of January 1, 2008; however the
amount of such proceeds has not been finally determined and could be more or less. The after-tax gain on sale
would be reflected in the capital and surplus of PICA and, while there can be no assurance, PICA estimates that
the statutory reporting impact from the realization of the value of its investment in the Wachovia Securities joint
venture upon closing of the put transaction in January 2010 would be a contribution of in excess of 100 points to
the RBC ratio of PICA as of the end of 2010.
Notwithstanding the terms of the joint venture agreements governing the ―lookback‖ put, PICA has from
time to time had discussions with Wells Fargo concerning a possible early settlement of the ―lookback‖ put.
The proceeds received upon any early settlement would take into account the time value of money, the benefits
and certainty provided by an early resolution and the form of consideration to be received. Taking into account
these factors, it could be expected that PFI may agree to an amount less than the amount that would be
recognized under a closing of the put transaction on or about January 1, 2010. Absent an early settlement, PFI
intends to exercise the ―lookback‖ put as described above.
In connection with the establishment of the Wachovia Securities joint venture, Wachovia Securities, LLC
issued a subordinated promissory note in the principal amount of $417 million, which is held by PICA. This
note bears interest, payable quarterly, at the three month London inter-bank rate (LIBOR) plus 105 basis points.
Under the terms of the joint venture agreements, this note becomes payable, together with accrued and unpaid
interest, within thirty days of termination of the joint venture.
On December 30, 2008, PICA entered into an agreement with PSG Holdings LLC, in which PSG Holdings,
LLC promises to pay PICA on March 30, 2010 the principal sum of $2.1 billion, together with simple interest
thereon per annum. The note, in the amount of $2.1 billion, related to this agreement is reported in Assets in
―Bonds‖ and is secured by the investment in Wachovia Securities.
The other wholly owned businesses in PSG Holdings, LLC, principally our global commodities group,
continue to maintain sufficiently liquid balance sheets, consisting mostly of cash and cash equivalents,
segregated client assets, and short-term receivables from clients, broker-dealers, and exchanges.
On December 24, 2008 PICA received a capital contribution of $150 million from its ultimate parent, PFI.
PICA has received a request pursuant to the documentation for the disposition of PFI‘s property and
casualty operations completed in 2003 to deposit into a trust cash or securities for the purpose of securing
insurance liabilities that were to have been transferred to PICA following completion of the disposition but that
have not been so transferred. PICA estimates that the amount of cash or securities to be deposited is
approximately $500 million, and PICA is allowed to satisfy a portion of this requirement through the deposit of
promissory notes received from the purchaser at the time of the disposition. PICA management believes that the
deposit of these assets is not a material liquidity event for PICA.
Net cash provided by operations was $466 million and $384 million for the three months ended March 31,
2009 and March 31, 2008, respectively. The fluctuation between years was primarily driven by a decrease in
benefits and claims paid.
Net cash (used in) provided by investing activities was ($334) million and $1,545 million for the three
months ended March 31, 2009 and March 31, 2008, respectively. The fluctuation between years was principally
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driven by a decrease in net cash flows related to investments in bonds. PICA‘s cash flows from investment
activities result from repayments of principal, proceeds from maturities and sales of invested assets and
investment income, net of amounts reinvested. The primary liquidity risks with respect to these cash flows are
the risk of default by debtors or bond insurers, our counterparties‘ willingness to extend repurchase and/or
securities lending arrangements and market volatility. We closely manage these risks through our credit risk
management process and regular monitoring of our liquidity position.
Net cash (used in) financing activities was ($2,455) million and ($1,636) million for the three months ended
March 31, 2009 and March 31, 2008, respectively. The fluctuation was mainly driven by payments made on
borrowed money.
PICA's management believes that its sources of liquidity are adequate to meet its current cash requirements
and reasonably foreseeable contingencies, particularly considering the liquidity of its investment portfolio.
Included in financing activity above were contractually scheduled maturities of general account GICs
totaling $2,132 million for the three months ended March 31, 2009. Because these contractual withdrawals, as
well as the level of surrenders experienced, were consistent with PICA's assumptions in asset liability
management, the associated cash outflows did not have an adverse impact on PICA‘s overall liquidity.
Additionally, PICA also considers the risk of policyholder and contractholder withdrawals of funds earlier
than our assumptions when selecting assets to support these contractual obligations. PICA uses surrender
charges and other contract provisions to mitigate the extent, timing and profitability impact of withdrawals of
funds by customers from annuity and deposit contracts. The following table sets forth withdrawal
characteristics of PICA's general account annuity reserves and deposit liabilities, based on statutory liability
values, as of the dates indicated.
March 31, 2009 December 31, 2008
Amount
% of
Total Amount % of
Total
($ in millions)
Not subject to discretionary withdrawal provisions ......................... $34,301 62 % $34,473 63 %
Subject to discretionary withdrawal, with adjustment:
With market value adjustment .................................................... 4,685 9 % 4,600 8 %
At market value .......................................................................... 1,127 2 % 1,058 2 %
At contract value, less surrender charge of 5% or more ............. 1,276 2 % 1,281 2 %
Subtotal ................................................................................. $41,389 7 5% $41,412 7 6%
Subject to discretionary withdrawal at contract value with
no surrender charge or surrender charge of less than 5%............ 13,729
25 % 13,544
24 %
Total annuity reserves and deposit liabilities ................................... $55,118 100 % $54,956 100 %
PICA believes that cash flows from its insurance, annuity and guaranteed products operations are adequate
to satisfy the current liquidity requirements of these operations based on its current liability structure and
considering a variety of reasonably foreseeable stress scenarios. The continued adequacy of this liquidity will
depend upon factors including future securities market conditions, changes in interest rate levels, policyholder
perceptions of PICA's financial strength and the relative safety of competing products, each of which could lead
to reduced cash inflows or increased cash outflows. In addition, market volatility can impact the level of capital
required to support our businesses, particularly our annuity business.
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PICA continues to operate with significant cash on its balance sheet and has access to alternate sources of
liquidity, as discussed below under ―Financing.‖ However, a continuation or worsening of the disruptions in the
credit and capital markets could adversely affect PICA and its ability to access sources of liquidity, as well as
threaten to reduce its capital below a level that is consistent with PICA‘s existing ratings objectives. Therefore,
PICA may need to take additional actions beyond those described above, which may include but are not limited
to: (1) undertake additional capital management activities, including recapture of liabilities previously ceded to
our off-shore captive reinsurance subsidiary and/or reinsurance transactions; (2) access to alternative sources of
liquidity; (3) access to external sources of capital, including the debt markets, or equity markets through PFI; (4)
utilize further proceeds from our outstanding retail medium-term notes for general corporate purposes by
accelerating repayments under additional funding agreements; (5) transfer ownership of certain subsidiaries of
PFI to PICA; (6) take additional actions related to derivatives; (7) limiting or curtailing sales of certain products
and/or restructuring existing products; (8) undertaking asset sales; and (9) seeking temporary or permanent
changes to regulatory rules. Certain of these capital management activities may require regulatory approval.
As of March 31, 2009 and December 31, 2008, PICA had cash and short-term investments of
approximately $5.6 billion and $7.8 billion, respectively, and investment grade bonds with a fair market value of
$76.9 billion and $78.8 billion, respectively.
Non-Insurance Contractual Obligations
The following table presents PICA's contractual cash flow commitments on notes payable and other
borrowings and surplus notes, excluding interest payable, as of March 31, 2009. This table does not reflect
PICA's obligations under its insurance, annuity and guaranteed products contracts.
Payment Due by Period
Total
Less than 1
Year
1-3
Years
4-5
Years
After 5
Years
($ in millions) Notes payable and other borrowings (1) ...... $ 3,274 $ 1,228 $ 2,046 $ — $ —
Surplus notes (2) .......................................... 450 — — — 450
Total ............................................................. $ 3,724 $ 1,228 $ 2,046 $ — $ 450
(1) The amounts for notes payable and other borrowings represent scheduled principal repayments on debt. The amount reported on
the balance sheet of the statutory financial statements represents the carrying value. The balance sheet amount decreased from
$5,566 million as of December 31, 2008 to $3,279 million as of March 31, 2009 due to paydown of inter-company debt with PF.
(2) The amounts for surplus notes represent the aggregate principal amounts. The amount reported in the capital and surplus section
of the statutory financial statements represents the current statement value.
In addition to the amounts shown above, PICA is party to operating leases for which its future minimum
lease payments under non-cancelable leases were $362 million and $351 million as of March 31, 2009 and
December 31, 2008, respectively.
Certain real estate funds under management are held for the benefit of clients in insurance company separate
accounts sponsored by PICA. In the normal course of business, these separate accounts enter into purchase
commitments which include commitments to purchase real estate, invest in future real estate partnerships, and/or
fund additional construction or other expenditures on previously acquired real estate investments. Certain
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purchases of real estate are contingent on the developer‘s development of the real estate according to plans and
specifications outlined in a pre-sale agreement or the property achieving a certain level of leasing. Purchase
commitments are typically entered into by PICA on behalf of the particular separate account and, upon
acquisition, are titled either in PICA or an LLC subsidiary formed for that purpose. In certain cases, the
commitments specify that recourse on the obligation is limited to the assets of the separate account.
As of March 31, 2009, these separate account portfolios had $10.1 billion of outstanding purchase
commitments, of which $3.8 billion are anticipated to become due in 2009 and others may become due upon a
failure to maintain required loan to value ratios or to satisfy other financial covenants. Of the $10.1 billion of
total commitments, $5.1 billion are full recourse to PICA, of which $2.1 billion are anticipated to become due in
2009. Of the $10.1 billion of total commitments, $6.9 billion represents commitments that are not reflected on
PICA‘s balance sheet as of March 31, 2009. These separate accounts have also entered into syndicated credit
facilities providing for borrowings in the aggregate amount of $1.07 billion, of which $0.6 billion was
outstanding at March 31, 2009. These facilities also include loan to value ratio requirements and other financial
covenants. Recourse on obligations under these facilities is limited to the assets of the applicable separate
account. As of March 31, 2009, the separate account portfolios had a combined net asset value of $14.9 billion.
At the time of maturity of a commitment obligation, PICA often endeavors to negotiate extensions,
refinancings or other solutions with creditors. Management believes that the separate accounts have sufficient
resources to ultimately meet their obligations. However, because of the volatility and disruption in the credit
and capital markets, the separate accounts may not be able to timely fund all maturing obligations from regular
sources such as asset sales, operating cash flow, deposits from clients and debt refinancings or from the above-
mentioned portfolio level credit facilities. In cases where the separate account is not able to fund maturing
obligations, PICA may be called upon or required to provide interim funding solutions.
During the normal course of its business, PICA utilizes financial instruments with off-balance sheet credit
risk such as commitments and financial guarantees. Commitments primarily include commitments to fund
investments in private placement securities, limited partnerships and other investments, as well as commitments
to originate mortgage loans. As of March 31, 2009, these commitments were $9.291 billion including $6.850
billion that PICA anticipates will be funded from the assets of the separate accounts. Of these separate account
commitments, $2.737 billion have recourse to PICA if the separate accounts are unable to fund the amounts
when due. PICA also provides financial guarantees incidental to other transactions. These credit-related
financial instruments have off-balance sheet credit risk because only their origination fees, if any, and accruals
for probable losses, if any, are recognized until the obligation under the instrument is fulfilled or expires. These
instruments can extend for several years and expirations are not concentrated in any period. PICA seeks to
control credit risk associated with these instruments by limiting credit, maintaining collateral where customary
and appropriate, and performing other monitoring procedures.
In the course of PICA‘s business, it provides certain guarantees and indemnities to third parties pursuant
to which it may be contingently required to make payments now or in the future.
A number of guarantees provided by PICA relate to real estate investments held in its separate accounts,
in which the separate account has borrowed funds, and PICA has guaranteed their obligation to their lender.
PICA provides these guarantees to assist the separate account in obtaining financing for the transaction. The
Company‘s maximum potential exposure under these guarantees was $1.833 billion at March 31, 2009, of which
all but $346 million is limited to the assets of the separate account for which exposure primarily relates to
guarantees limited to fraud, criminal activity or other bad acts. These guarantees generally expire at various
times over the next fifteen years. At March 31, 2009, no amounts were accrued as a result of PICA‘s assessment
that it is unlikely payments will be required. Any payments that may become required of PICA under these
guarantees would either first be reduced by proceeds received by the creditor on a sale of the underlying
collateral, or would provide PICA with rights to obtain the underlying collateral.
Certain contracts underwritten by the Retirement business include guarantees related to financial assets
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owned by the guaranteed party. These contracts are accounted for as derivatives, at fair value. At March 31,
2009, such contracts in force carried a total guaranteed value of $5.790 billion. These guarantees are supported
by collateral that is not reflected on our balance sheet. This collateral had a fair value of $5.693 billion as of
March 31, 2009.
Contingencies
PICA has entered into reinsurance agreements with PLIC, PLICK, and PLICT, all of which are affiliates
of PICA. In each case, PICA has agreed to reinsure certain individual life insurance policies through a yearly
renewable term contract. Additionally, in 2005, PICA agreed to assume, on a co-insurance basis, U.S. dollar-
denominated annuities from Gibraltar. Beginning February 1, 2007, new business is no longer being reinsured
from Gibraltar. During the third quarter of 2007, Gibraltar recaptured the remainder of the liabilities related to
its U.S. dollar denominated fixed annuities previously reinsured with PICA. Furthermore, PICA has agreed to
co-insure U.S. dollar-denominated policies sold by PLIC. For these reinsurance policies assumed, PICA has
ceded the majority of these reinsurance policies to subsidiary companies.
PICA has committed to repurchase securities under master repurchase agreements in the amount of $2,106
million as of March 31, 2009. PICA conducts asset-based or secured financing, including transactions such as
securities lending and repurchase agreements, primarily to earn spread income or borrow funds. These programs
are driven by portfolio holdings in securities that are lendable based on counterparty demand for these securities
in the marketplace. The collateral received in connection with these programs is primarily used to purchase
securities in PICA‘s short-term spread portfolios. Investments held in the enhanced short-term spread portfolio
include cash and cash equivalents, short-term investments and fixed maturities, including mortgage- and asset-
backed securities, with a weighted average life at time of purchase of two years or less. A portion of the asset-
backed securities held in PICA‘s short-term spread portfolio, including PICA‘s enhanced short-term portfolio,
are collateralized by sub-prime mortgages. See ―Bonds‖ above for a further discussion on PICA‘s asset-backed
securities collateralized by sub-prime mortgages, including details regarding those securities held in PICA‘s
enhanced short-term spread portfolio. These short-term spread portfolios are subject to specific investment
policy statements, which among other things, do not allow for significant asset/liability interest rate duration
mismatch.
Financing
PF, a wholly owned subsidiary of PICA, continues to serve as a source of financing for PICA and its
subsidiaries, as well as for other subsidiaries of PFI. PF operates under a support agreement with PICA whereby
PICA has agreed to maintain PF's positive tangible net worth at all times. PF borrows funds primarily through
the direct issuance of commercial paper. PF‘s outstanding loans to other subsidiaries of PFI have declined over
time as it transitions into a financing company primarily for PICA and its remaining subsidiaries. As of March
31, 2009, PF had a tangible net worth of $19.3 million and short-term and long-term notes outstanding of $2,573
million and $249 million, respectively.
PF has a commercial paper program, rated "A-1+" by S&P, "P-1" by Moody's and "F1" by Fitch with a
current authorized capacity of $12.0 billion. The rating from Moody‘s is currently on review for a possible
downgrade and the Fitch rating has a negative outlook. PF's outstanding commercial paper and master note
borrowings were $2.573 billion as of March 31, 2009, a decrease of $1.781 billion from December 31, 2008 due
to a reduction in the investment in our enhanced short-term portfolio and repayment of loans by our affiliates,
funded through a combination of asset sales, cash collateral from asset based financing, and other internal
sources of cash. As of March 31, 2009, $743 million of this outstanding commercial paper was held in cash and
cash equivalents and $116 million of the proceeds were invested in our enhanced short-term portfolio. The daily
average commercial paper outstanding during the first quarter of 2009 under this program was $4.831 billion.
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The weighted average interest rates on these borrowings were 0.90% and 3.37% for the three months ended
March 31, 2009 and 2008, respectively.
Based on PF‘s current commercial paper rating, its commercial paper program is eligible to participate in
the Commercial Paper Funding Facility, or CPFF, sponsored by the Federal Reserve Bank of New York. PF's
commercial paper program must maintain ratings of at least A-1/P-1/F1 by at least two rating agencies in order
to be eligible for the program. CPFF purchases eligible three-month unsecured and asset-backed U.S. dollar
denominated commercial paper from eligible issuers. The maximum amount of commercial paper an issuer can
sell to the CPFF is equivalent to the greatest amount of U.S. dollar denominated commercial paper the issuer
had outstanding during any single day between January 1, 2008 and August 31, 2008 less the outstanding
amount of any non-CPFF commercial paper at the applicable time. The greatest amount of commercial paper PF
had outstanding during such period was $9.815 billion on March 18, 2008. Unsecured commercial paper
purchased by the CPFF will be discounted based on a rate equal to a spread (200 basis points) over the three-
month overnight index swap rate on the day of purchase. As of March 31, 2009, PF had $750 million of
commercial paper outstanding under the CPFF, with a weighted average maturity of 30 days. Access to the
CPFF is scheduled to terminate on October 30, 2009, unless such date is extended by the Federal Reserve Bank
of New York. As of the filing date of this report, there are no CPFF borrowings outstanding.
While management considers the availability of commercial paper as one of PICA‘s alternative sources of
liquidity, management has continued to reduce PICA‘s reliance on commercial paper to fund its operations, and
has developed plans which would enable PICA to further reduce, or if necessary eliminate, further borrowings
under the PF commercial paper program, through the use of other sources of liquidity.
The PF commercial paper program is backed by unsecured committed lines of credit. As of March 31, 2009,
PFI, PICA and PF had unsecured committed lines of credit totaling $4.34 billion. This amount included a $1.94
billion 5-year credit facility that expires May 2012, which includes 20 financial institutions, and an additional
$2.4 billion credit facility, of which $200 million expires in December 2011 and $2.2 billion expires in
December 2012, which includes 18 financial institutions. The available credit and number of lenders reflects the
removal in January 2009 of Lehman Commercial Paper Inc., which filed for bankruptcy in October 2008 , and
had been a participant in the amount of $60 million, and Lehman Brothers Bank FSB which had been a
participant in the amount of $100 million. Within each facility, no single financial institution has more than 15%
of the total committed credit. Borrowings under the outstanding facilities will mature no later than the
respective expiration dates of the facilities and will bear interest at the rates set forth in each facility agreement.
There were no outstanding borrowings under any of these facilities as of March 31, 2009. The ability to borrow
under these facilities is conditioned on the continued satisfaction of customary conditions, including
maintenance at all times by PICA of total adjusted capital of at least $5.5 billion based on SAP and PFI‘s
maintenance of consolidated net worth of at least $12.5 billion, which for this purpose is based on GAAP
stockholders‘ equity, excluding net unrealized gains and losses on investments. PICA‘s ability to borrow under
these facilities is not contingent on its credit ratings or subject to material adverse change clauses. As of March
31, 2009 PICA's total adjusted capital and PFI‘s consolidated GAAP stockholders‘ equity, excluding net
unrealized gains and losses on investments, exceeded the minimum amounts of required to borrow under these
facilities.
In 2003, PICA established a Funding Agreement Notes Issuance Program pursuant to which a Delaware
statutory trust issues medium-term notes secured by funding agreements issued to the trust by PICA. The
funding agreements provide cash flow sufficient for the debt service on the medium-term notes. The medium-
term notes are sold in transactions not requiring registration under the Securities Act of 1933, as amended. The
notes have fixed or floating interest rates and original maturities ranging from two to seven years. Under SAP,
debt of subsidiaries is not included in debt of PICA. Similarly, under SAP, debt of variable interest entities such
as the trust is not included in debt of PICA. As a result, the medium-term notes are not included in the line item
―Notes payable and other borrowings‖ on PICA‘s Statutory Statements of Admitted Assets, Liabilities and
Capital and Surplus. In the third quarter of 2006, the authorization amount of the program was increased from
$6 billion to $15 billion. As of March 31, 2009 and December 31, 2008, the outstanding aggregate principal
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amount of medium-term notes under the program totaled approximately $6.5 billion and $7.1 billion,
respectively. The decrease in outstanding aggregate principal amount of such notes is reflective of maturities
during the first quarter of 2009. The aggregate principal amount of these notes that mature over the next 12
months is approximately $1.7 billion. In the event we are unable to sell new notes under this program, we intend
to repay the maturing notes through a combination of cash flows from asset maturities, asset sales, and internal
sources of funds such as PF. Liabilities under the funding agreements issued by PICA to the trust in connection
with each tranche of medium-term notes are included, along with liabilities relating to other funding agreements,
in the line item ―Policyholders‘ account balances‖ on PICA‘s Statutory Statements of Admitted Assets,
Liabilities and Capital and Surplus.
In June 2008, PICA became a member of the Federal Home Loan Bank of New York (―FHLBNY‖).
Membership allows PICA to participate in FHLBNY's product line of financial services, including collateralized
advances, collateralized funding agreements and general asset/liability management that can be used for
liquidity management and as an alternative source of funding. PICA‘s membership in FHLBNY requires us to
maintain ownership of member stock and any borrowings from FHLBNY will require PICA to purchase
FHLBNY activity based stock in an amount equal to 4.5% of the borrowings.
Under guidance of the NJDOBI, the total amount of qualifying mortgage-related assets and U.S. treasury
securities that can be pledged as collateral by PICA to FHLBNY is limited to 5% of the prior year‘s admitted
assets of PICA exclusive of separate account assets, which equates to $7.5 billion based on admitted assets as of
December 31, 2007. Based on this permitted amount, the eligible securities available to PICA, and net of the
4.5% activity based stock PICA would be obligated to purchase from FHLBNY based on maximum borrowings,
the estimated total borrowing capacity with the FHLBNY is approximately $6.5 billion, as of March 31, 2009.
The fair value of the qualifying assets pledged as collateral by PICA must be maintained at certain specified
levels of the borrowed amount, which can vary, depending on the nature of the assets pledged. If the fair value
of the collateral declines below these levels, PICA would be required to pledge additional collateral or repay
outstanding borrowings. As of March 31, 2009, PICA pledged qualifying assets with a fair value of $5.4 billion,
which is above the minimum level required by the FHLBNY, and had outstanding borrowings of $4.5 billion, of
which $3 billion is reflected in ―Notes payable and other borrowings‖ and $1.5 billion is reflected in
―Policyholders‘ account balances.‖ Of the outstanding FHLBNY borrowings as of March 31, 2009, $1.0 billion
matured and was repaid in April 2009 and the remaining borrowings have maturities ranging from June 4, 2010
to December 6, 2010. At March 31, 2009, FHLBNY proceeds of $1.1 billion were invested in cash and short
term investments at PICA, $1.2 billion was used to support the operating needs of our businesses, $300 million
was used to fund loans to affiliates and the balance was used to purchase investments, including the requisite
FHLBNY activity based stock. PICA, from time to time, may borrow additional funds from FHLBNY for
purposes of managing its liquidity, asset/liability management, or issuance of funding agreements.
In February and March 2009, PICA issued collateralized funding agreements in an aggregate amount of
$1.5 billion to the FHLBNY. The funding agreements, which are reflected in ―Policyholders‘ account
balances,‖ have priority claim status above debt holders of PICA. Of these funding agreements, $1.0 billion
currently serves as a substitute funding source for a product of PICA‘s retirement business for which PICA
earns investment spread that was previously funded by retail medium-term notes issued by PFI. This
substitution allows PFI to use the proceeds from the sale of the corresponding retail medium-term notes for
general corporate purposes. To effect the substitution, as of March 31, 2009, $1.015 billion of intercompany
funding agreements that were previously issued by PICA to PFI were terminated for a payment of $730 million
from PICA to PFI. The termination of the funding agreements at a discount to par, based on an estimate of
current market value of the liability, resulted in an increase to PICA's capital of $285 million, representing the
difference between the principal amount of the funding agreements so terminated and the amount of the
termination payment. PFI and PICA may conduct similar transactions, or take other actions, in future periods in
order to utilize additional retail medium-term notes proceeds for general corporate purposes, including by using
the additional $500 million of funding agreements issued to the FHLBNY for this purpose.
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On May 8, 2009, NJDOBI revised its prior guidance to increase the maximum amount of qualifying assets
that PICA may pledge to the FHLBNY from 5% to 7% of its prior year-end statutory net admitted assets
exclusive of separate account assets; however, this limitation resets to 5% on December 31, 2010 unless
extended by NJDOBI. Based on its statutory net admitted assets as of December 31, 2008, the 7% limitation
equates to a maximum amount of pledged assets of $10.5 billion and an estimated maximum borrowing
capacity, after taking into account applicable required collateralization levels and required purchases of activity
based FHLBNY stock, of approximately $9.0 billion. However, the ability to borrow from the FHLBNY is
subject to the availability and maintenance of qualifying assets at PICA, and there is no assurance that PICA
will have sufficient qualifying assets available to it in order to access the increased capacity in full at any
particular time. Also, the revised guidance from NJDOBI limits the aggregate amount of assets PICA may
pledge for all loans, including borrowings from the FHLBNY, to 10% of its prior year-end statutory net
admitted assets exclusive of separate account assets, subject to certain exceptions.
Capital
The Risk Based Capital, or RBC, ratio is the primary measure by which we evaluate the capital adequacy
of PICA and its other domestic life insurance subsidiaries. PICA‘s RBC ratio is managed to a level consistent
with an ―AA‖ ratings objective; however, ratings agencies take into account a variety of factors in assigning
ratings to PICA and its domestic life insurance subsidiaries in addition to RBC levels. RBC is determined by
statutory formulas that consider risks related to the type and quality of the invested assets, insurance-related
risks associated with an insurer‘s products, interest rate risks and general business risks. The RBC ratio
calculations are intended to assist insurance regulators in measuring the adequacy of an insurer‘s statutory
capitalization. The RBC ratio is an annual calculation; however, based upon March 31, 2009 amounts, the RBC
ratio for PICA and our other domestic life insurance subsidiaries would exceed the minimum level required by
applicable insurance regulations. The level of statutory capital of PICA and its domestic life insurance
subsidiaries is affected by the statutory accounting rules for loan-backed and structured securities. Mandatory
adoption of changes to these rules was recently deferred until periods ending on or after September 30, 2009.
Further changes to these rules by insurance regulators, or the timing of PICA‘s application of these rules, are
possible, given the deferral and other uncertainty around the resolution of these accounting rules. (The inclusion
of RBC measures is intended solely for the information of investors and is not intended for the purpose of
ranking any insurance company or for use in connection with any marketing, advertising or promotional
activities.)
Litigation and Regulatory Matters
PICA is subject to legal and regulatory actions in the ordinary course of its businesses, including class
action lawsuits. PICA's pending legal and regulatory actions include proceedings relating to aspects of PICA‘s
businesses and operations that are specific to it and proceedings that are typical of the businesses in which it
operates, including in both cases businesses that have either been divested or placed in wind-down status. PICA
is subject to class action lawsuits and individual lawsuits involving a variety of issues, including sales practices,
underwriting practices, claims payment and procedures, additional premium charges for premiums paid on a
periodic basis, denial or delay of benefits, return of premiums or excessive premium charges and breaching
fiduciary duties to customers. In its investment-related operations, PICA is subject to litigation involving
commercial disputes with counterparties or partners and class action lawsuits and other litigation alleging,
among other things, that PICA has made improper or inadequate disclosures in connection with the sale of assets
and annuity and investment products or charged excessive or impermissible fees on these products,
recommended unsuitable products to customers, mishandled customer accounts or breached fiduciary duties to
customers. PICA is also subject to litigation arising out of its general business activities, such as its
investments, contracts, leases and labor and employment relationships, including claims of discrimination and
harassment and could be exposed to claims or litigation concerning certain business or process patents.
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Regulatory authorities from time to time make inquiries and conduct investigations and examinations relating
particularly to PICA and its businesses and products. In addition, PICA, along with other participants in the
businesses in which it engages, may be subject from time to time to investigations, examinations and inquiries,
in some cases industry-wide, concerning issues or matters upon which such regulators have determined to focus.
In certain of these pending matters, plaintiffs are seeking large and/or indeterminate amounts, including punitive
or exemplary damages. The outcome of litigation or a regulatory matter, and the amount or range of potential
loss at any particular time, is inherently uncertain. The following is a summary of certain pending proceedings.
In April 2009, a purported class action, Schultz v. The Prudential Insurance Company of America, was
filed in the United States District Court for the Northern District of Illinois. Plaintiff, a participant in a defined
benefit plan governed by ERISA, alleges that pursuant to the terms of the group disability insurance policy
funding her plan benefits, PICA may not lawfully offset family social security disability benefits against PICA
contract benefits because social security benefits that members of her family received on account of her
disability were not ―loss of time‖ disability payments. The complaint alleges violations of ERISA, breach of
contract and unfair claims practices. Plaintiff seeks recovery of the amount her disability benefits were reduced
by the challenged offset, and additional monetary, declaratory and injunctive relief on behalf of a putative class
of similarly situated disability claimants who are covered under other plans or policies governed by ERISA and
on behalf of a putative class of similarly situated disability claimants who are participants in plans that are
exempt from ERISA.
In April 2009, PFI‘s Board of Directors (the "Board") received a letter demanding that the Board take
action to recover allegedly improperly paid compensation to certain current and former employees and executive
officers of PFI since at least 2005. The demand is made by a PFI stockholder, Service Employees International
Union Pension Plans Master Trust (―SEIU‖), and is one of many that SEIU has sent to large corporations. SEIU
claims that PFI must bring an action, under theories of unjust enrichment and corporate waste, to recoup
incentive compensation that was based on allegedly flawed economic metrics. SEIU also seeks rescission of
exercised stock options because the options were based on mistaken facts concerning the fair value of PFI‘s
stock. The letter states that between 2005 and 2008 PFI paid cash and equity compensation of approximately
$165 million to its senior executives and authorized senior executives to exercise stock options worth
approximately $66 million. The letter also demands that the Board enjoin any further approved, but unpaid,
compensation payments, overhaul PFI‘s compensation structure, and allow stockholders an advisory vote on the
Compensation Committee‘s report in PFI‘s annual proxy statement. SEUI reserves the right to bring a derivative
action should the Board decline to act. The Board has taken the letter under advisement.
In March 2009, a purported class action, Bauer v. Prudential Financial, et al., was filed in the United
States District Court for the District of New Jersey. The case names as defendants, PFI, certain PFI Directors,
Chief Financial Officer, Controller and former Chief Executive Officer and former Principal Accounting Officer
of PFI, underwriters and PFI‘s independent auditors. The complaint, brought on behalf of purchasers of PFI‘s
9% Junior Subordinated Notes (retail hybrid subordinated debt), alleges that PFI‘s March 2006 Form S-3
Registration Statement and Prospectus and the June 2008 Prospectus Supplement, both of which incorporated
other public filings, contained material misstatements or omissions. In light of PFI‘s disclosures in connection
with its 2008 financial results, plaintiffs contend that the earlier offering documents failed to disclose
impairments in PFI‘s asset-backed securities collateralized with subprime mortgages and goodwill associated
with certain subsidiaries and other assets, and that PFI had inadequate controls relating to such reporting. The
complaint asserts violations of the Securities Act of 1933, alleging Section 11 claims against all defendants,
Section 12(a)(2) claims against PFI and underwriters and Section 15 claims against the individual defendants,
and seeks unspecified compensatory and rescissory damages, interest, costs, fees, expenses and such injunctive
relief as may be deemed appropriate by the court. In April 2009, two additional purported class action
complaints were filed in the same court, Haddock v. Prudential Financial, Inc. et al. and Pinchuk v. Prudential
Financial, Inc. et al. The complaints essentially allege the same claims and seek the same relief as Bauer.
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In November 2008, a purported nationwide class action, Garcia v. Prudential Insurance Company of
America, was filed in the United States District Court for the District of New Jersey. The complaint, which was
brought on behalf of beneficiaries of PICA policies whose death benefits were placed in retained asset accounts,
alleges that by investing the death benefits in these accounts, PICA wrongfully delayed payment and improperly
retained undisclosed profits. It alleges claims of breach of the contract of insurance, breach of contract with
regard to the retained asset accounts, breach of fiduciary duty and unjust enrichment, and seeks an accounting,
disgorgement, injunctive relief, attorneys‘ fees, and prejudgment and post-judgment interest. In March 2009,
PICA filed a motion to dismiss the complaint.
In October 2007, PRIAC filed an action in the United States District Court for the Southern District of
New York, Prudential Retirement Insurance & Annuity Co. v. State Street Global Advisors, in PRIAC‘s
fiduciary capacity and on behalf of certain defined benefit and defined contribution plan clients of PRIAC,
against an unaffiliated asset manager, State Street Global Advisors (―SSgA‖) and SSgA‘s affiliate, State Street
Bank and Trust Company (―State Street‖). This action seeks, among other relief, restitution of certain losses
attributable to certain investment funds sold by SSgA as to which PRIAC believes SSgA employed investment
strategies and practices that were misrepresented by SSgA and failed to exercise the standard of care of a
prudent investment manager. PRIAC also intends to vigorously pursue any other available remedies against
SSgA and State Street in respect of this matter. Given the unusual circumstances surrounding the management
of these SSgA funds and in order to protect the interests of the affected plans and their participants while PRIAC
pursues these remedies, PRIAC implemented a process under which affected plan clients that authorized PRIAC
to proceed on their behalf have received payments from funds provided by PRIAC for the losses referred to
above. PFI‘s consolidated financial statements, and the results of PRIAC, for the year ended December 31,
2007 include a pre-tax charge of $82 million, reflecting these payments to plan clients and certain related costs.
These are reflected in PICA‘s financial statements, within change in net unrealized capital gains (losses),
prepared on the basis of SAP. In September 2008, the court denied the State Street defendants‘ motion to
dismiss the claims for damages and other relief under Section 502(a)(2) of ERISA, but dismissed the claims for
equitable relief under Section 502(a)(3) of ERISA. In October 2008, defendants answered the complaint and
asserted counterclaims for contribution and indemnification, defamation and violations of Massachusetts‘ unfair
and deceptive trade practices law.
PICA, along with a number of other insurance companies, received formal requests for information
from the State of New York Attorney General‘s Office (―NYAG‖), the SEC, the Connecticut Attorney
General‘s Office, the Massachusetts Office of the Attorney General, the Department of Labor, the United States
Attorney for the Southern District of California, the District Attorney of the County of San Diego, and various
state insurance departments relating to payments to insurance intermediaries and certain other practices that may
be viewed as anti-competitive. In December 2006, PICA reached a resolution of the NYAG investigation.
Under the terms of the settlement, PICA paid a $2.5 million penalty and established a $16.5 million fund for
policyholders, adopted business reforms and agreed, among other things, to continue to cooperate with the
NYAG in any litigation, ongoing investigations or other proceedings. PICA also settled the litigation brought by
the California Department of Insurance and agreed to business reforms and disclosures as to group insurance
contracts insuring customers or residents in California and to pay certain costs of investigation. In April 2008,
PICA reached a settlement of proceedings relating to payments to insurance intermediaries and certain other
practices with the District Attorneys of San Diego, Los Angeles and Alameda counties. Pursuant to this
settlement, PICA paid $350,000 in penalties and costs. These matters are also the subject of litigation brought by
private plaintiffs, including purported class actions that have been consolidated in the multidistrict litigation in
the United States District Court for the District of New Jersey, In re Employee Benefit Insurance Brokerage
Antitrust Litigation. In August and September 2007, the court dismissed the anti-trust and RICO claims. In
January 2008 and February 2008, the court dismissed the ERISA claims with prejudice and the state law claims
without prejudice. Plaintiffs have appealed to the Third Circuit Court of Appeals.
In October 2006, a class action lawsuit, Bouder v. Prudential Financial, Inc. and Prudential Insurance
Company of America, was filed in the United States District Court for the District of New Jersey, claiming that
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PICA failed to pay overtime to insurance agents who were registered representatives in violation of federal and
Pennsylvania law, and that improper deductions were made from these agents‘ wages in violation of state law.
The complaint seeks back overtime pay and statutory damages, recovery of improper deductions, interest and
attorneys‘ fees. In March 2008, the court conditionally certified a nationwide class. In March 2008, a purported
nationwide class action lawsuit was filed in the United States District Court for the Southern District of
California, Wang v. Prudential Financial, Inc. and Prudential Insurance, on behalf of agents who sold PICA‘s
financial products. The complaint alleges claims that PICA failed to pay overtime and provide other benefits in
violation California and federal law and seeks compensatory and punitive damages in unspecified amounts. In
September 2008, the Wang matter was transferred to the United States District Court for the District of New
Jersey and consolidated with the Bouder matter. In January 2009, an amended complaint was filed in the
consolidated matter which adds wage claims based on the laws of thirteen additional states. In March 2009, a
second amended complaint was filed which dropped the breach of contract claims. PFI moved to dismiss certain
of the state claims in the consolidated complaint.
In April 2005, PFI voluntarily commenced a review of the accounting for its reinsurance arrangements
to confirm that it complied with applicable accounting rules. This review included an inventory and
examination of current and past arrangements, including those relating to PFI‘s wind-down and divested
businesses and discontinued operations. Subsequent to commencing this voluntary review, PFI received a
formal request from the Connecticut Attorney General for information regarding its participation in reinsurance
transactions generally and a formal request from the SEC for information regarding certain reinsurance contracts
entered into with a single counterparty since 1997 as well as specific contracts entered into with that
counterparty in the years 1997 through 2002 relating to PFI‘s property and casualty insurance operations that
were sold in 2003. In August 2008, PFI reached a resolution of this matter. The SEC‘s complaint, filed on
August 6, 2008 in the United States District Court for the District of New Jersey, alleges, among other things,
that PFI improperly accounted for the reinsurance contracts resulting in overstatements of PFI‘s consolidated
results for the years 2000, 2001 and 2002 in certain of PFI‘s reports filed with the SEC under the Exchange Act,
in violation of the financial reporting, books-and-records and internal control provisions of the Exchange Act
and related rules and regulations of the SEC thereunder. In connection with the settlement, PFI has consented to
entry of a final judgment enjoining it from future violations of specified provisions of the Exchange Act and
related rules and regulations of the SEC thereunder. The settlement, in which PFI neither admits nor denies the
allegations in the complaint, resolves the SEC‘s investigations into these matters without the imposition of any
monetary fine or penalty. The settlement documents include allegations that may result in litigation, adverse
publicity and other potentially adverse impacts to PFI‘s businesses.
From November 2002 to March 2005, eleven separate complaints were filed against PFI, PICA and the
law firm of Leeds Morelli & Brown in New Jersey state court. The cases were consolidated for pre-trial
proceedings in New Jersey Superior Court, Essex County and captioned Lederman v. Prudential Financial, Inc.,
et al. The complaints allege that an alternative dispute resolution agreement entered into among PICA, over 350
claimants who are current and former PICA employees, and Leeds Morelli & Brown (the law firm representing
the claimants) was illegal and that PICA conspired with Leeds Morelli & Brown to commit fraud, malpractice,
breach of contract, and violate racketeering laws by advancing legal fees to the law firm with the purpose of
limiting PFI‘s and PICA‘s liability to the claimants. In 2004, the Superior Court sealed these lawsuits and
compelled them to arbitration. In May 2006, the Appellate Division reversed the trial court‘s decisions, held that
the cases were improperly sealed, and should be heard in court rather than arbitrated. In March 2007, the court
granted plaintiffs‘ motion to amend the complaint to add over 200 additional plaintiffs, and a claim under the
New Jersey discrimination law, but denied without prejudice plaintiffs‘ motion for a joint trial on liability issues.
In June 2007, PFI and PICA moved to dismiss the complaint. In November 2007, the court granted the motion,
in part, and dismissed the commercial bribery and conspiracy to commit malpractice claims, and denied the
motion with respect to other claims. In January 2008, plaintiffs filed a demand pursuant to New Jersey law
stating that they were seeking damages in the amount of $6.5 billion.
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PICA's litigation and regulatory matters are subject to many uncertainties, and given their complexity
and scope, the outcomes cannot be predicted. It is possible that PICA‘s results of operations or cash flow of
PICA in a particular quarterly or annual period could be materially affected by an ultimate unfavorable
resolution of pending litigation and regulatory matters depending, in part, upon the results of operations or cash
flow for such period. In light of the unpredictability of PICA‘s litigation and regulatory matters, it is also
possible that in certain cases an ultimate unfavorable resolution of one or more pending litigation or regulatory
matters could have a material adverse effect on PICA‘s financial position. Management believes, however, that,
based on information currently known to it, the ultimate outcome of all pending litigation and regulatory
matters, after consideration of applicable reserves and rights to indemnification, is not likely to have a material
adverse effect on PICA‘s financial position.
Recent Information Regarding Tax
PICA‘s liability for income taxes includes the liability for unrecognized tax benefits and interest and
penalties which relate to tax years still subject to review by the Internal Revenue Service (―IRS‖) or other taxing
jurisdictions. Audit periods remain open for review until the statute of limitations has passed. Generally, for tax
years which produce net operating losses, capital losses or tax credit carryforwards (―tax attributes‖), the statute
of limitations does not close, to the extent of these tax attributes, until the expiration of the statute of limitations
for the tax year in which they are fully utilized. The completion of review or the expiration of the statute of
limitations for a given audit period could result in an adjustment to the liability for income taxes. The statute of
limitations for the 2002 and 2003 tax years is set to expire in 2009. It is reasonably possible that the total net
amount of unrecognized tax benefits will decrease anywhere from $0 to $169 million within the next 12 months
due to the expiration of the statute of limitations. Taxable years 2004 through 2008 are still open for IRS
examination.
The dividends received deduction (―DRD‖) reduces the amount of dividend income subject to U.S. tax
and in recent years has been the primary component of the difference between PICA's effective tax rate and the
federal statutory tax rate of 35%. The DRD for the current period was estimated using information from 2008,
current year results, and was adjusted to take into account the current year‘s equity market performance. The
actual current year DRD can vary from the estimate based on factors such as, but not limited to, changes in the
amount of dividends received that are eligible for the DRD, changes in the amount of distributions received
from mutual fund investments, changes in the account balances of variable life and annuity contracts, and
PICA‘s taxable income before the DRD.
In August 2007, the IRS released Revenue Ruling 2007-54, which included, among other items,
guidance on the methodology to be followed in calculating the DRD related to variable life insurance and
annuity contracts. In September 2007, the IRS released Revenue Ruling 2007-61. Revenue Ruling 2007-61
suspends Revenue Ruling 2007-54 and informs taxpayers that the U.S. Treasury Department and the IRS intend
to address through new regulations the issues considered in Revenue Ruling 2007-54, including the
methodology to be followed in determining the DRD related to variable life insurance and annuity contracts.
These activities had no impact on PICA‘s 2008 or 2009 results. A change in the DRD, including the possible
retroactive or prospective elimination of this deduction through regulation or legislation, could increase PFI‘s
actual tax expense and reduce PFI‘s consolidated net income.
On May 11, 2009, the Obama Administration released the ―General Explanations of the
Administration‘s Revenue Proposals.‖ Although the Administration has not released proposed statutory
language, the ―General Explanations of the Administration‘s Revenue Proposals‖ includes proposals which if
enacted, would affect the taxation of life insurance companies and certain life insurance products. In particular,
the proposals would affect the treatment of corporate owned life insurance policies or ―COLIs‖ by limiting the
availability of certain interest deductions for companies that purchase those policies. The proposals would also
change the method used to determine the amount of dividend income received by a life insurance company on
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assets held in separate accounts used to support variable life insurance and variable annuity contracts that is
eligible for the DRD. The DRD reduces the amount of dividend income subject to tax and is a significant
component of the difference between PICA‘s actual tax expense and expected amount determined using the
federal statutory tax rate of 35%. If proposals of this type were enacted, PICA‘s sale of COLI, variable
annuities, and variable life products could be adversely affected and PICA‘s actual tax expense could increase,
reducing earnings.
The General Explanation of the Administration‘s Revenue Proposals also includes proposals that would
change the method by which multinational corporations could claim credits for the foreign taxes they pay and
that would change the timing of deductions for expenses that are allocable to foreign-source income. More
specifically, it is likely that the proposals would impose additional restrictions on PICA‘s ability to claim
foreign tax credits on un-repatriated earnings. The proposals would also require U.S. multinationals to defer
certain deductions for ordinary and necessary business expenses that are allocable to foreign source income until
that related income is subject to U.S. tax. Unused deductions would be carried forward to future years. If
proposals of this type were enacted, PICA‘s actual tax expense could increase, reducing earnings.
In December 2006, the IRS completed all fieldwork with respect to its examination of PFI‘s
consolidated federal income tax returns for tax years 2002 and 2003. The final report was initially submitted to
the Joint Committee on Taxation for their review in April 2007. The final report was resubmitted in March 2008
and again in April 2008. The Joint Committee returned the report to the IRS for additional review of an industry
issue regarding the methodology for calculating the DRD related to variable life insurance and annuity contracts.
The IRS completed its review of the issue and proposed an adjustment with respect to the calculation of the
DRD. In order to expedite receipt of an income tax refund related to the 2002 and 2003 years, PICA has agreed
to such adjustment. Nevertheless, PICA believes that its return position is technically correct. Therefore, PICA
intends to file a protective refund claim to recover the taxes associated with the agreed upon adjustment and to
pursue such other actions as appropriate. The report, with the adjustment, was submitted to the Joint Committee
on Taxation in October 2008. PICA was advised on January 2, 2009 that the Joint Committee completed its
consideration of the report and has taken no exception to the conclusions reached by the IRS. Accordingly, the
final report was processed and a refund was received in February 2009. The statute of limitations for these years
is set to expire during 2009. These activities had no impact on PICA‘s 2008 or first quarter 2009 results.
In January 2007, the IRS began an examination of the consolidated U.S. federal income tax years 2004
through 2006. For the consolidated U.S. federal income tax years 2007 and 2008, PFI participated in the IRS‘s
Compliance Assurance Program (―CAP‖). Under CAP, the IRS assigns an examination team to review
completed transactions contemporaneously during the 2007 and 2008 tax years in order to reach agreement with
PFI on how they should be reported in the tax return. If disagreements arise, accelerated resolutions programs
are available to resolve the disagreements in a timely manner before the tax return is filed. It is management‘s
expectation this program will shorten the time period between the filing of PFI‘s federal income tax return and
the IRS‘s completion of its examination of the return.
Ratings Developments
In view of the difficulties experienced by many financial institutions, the rating agencies have heightened
the level of scrutiny that they apply to such institutions, have increased the frequency and scope of their credit
reviews, have requested additional information from the companies that they rate, and may adjust upward the
capital and other requirements employed in the rating agency models for maintenance of certain ratings levels.
In addition, actions taken to access third party financing, as discussed above, may in turn cause rating agencies
to reevaluate these ratings.
A down grade in the credit or financial strength (i.e., claims-paying) ratings of PFI or its rated subsidiaries
could potentially, among other things, limit PICA‘s ability to market products, reduce competitiveness, increase
the number or value of policy surrenders and withdrawals, increase borrowing costs and potentially make it
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more difficult to borrow funds, adversely affect the availability of financial guarantees, such as letters of credit,
cause additional collateral requirements or other required payments under certain agreements and/or hurt
PICA‘s relationships with creditors or trading counterparties. Additional collateral requirements or other
required payments under certain agreements are eligible to be satisfied in cash or by posting securities held by
the subsidiaries subject to the agreements. In addition, a ratings downgrade by A.M. Best to ―A-‖ for PICA and
its domestic life insurance subsidiaries would require PICA to post a letter of credit in the amount of $1.5 billion
that would result in an estimated annual cash outflow of approximately $180 million, or collateral posting in the
form of cash or securities to be held in a trust. Management believes that the posting of such collateral would
not be a material liquidity event for PICA. During the fourth quarter of 2008, Fitch Ratings downgraded (with a
negative outlook) PFI‘s senior debt rating to ‗A-‗ from ‗A‘, the insurer financial strength rating of PICA to ‗AA-
‘ from ‗AA‘ and the PRICOA Global Funding I program rating to ‗AA-‗ from ‗AA‘. During the first quarter of
2009, rating agencies took the following steps with respect to PFI and its subsidiaries:
On February 17, 2009, S&P lowered PFI‘s long-term senior debt rating to ―A‖ from ―A+‖ and affirmed the
―AA‖ ratings of PICA. The long-term ratings outlook was revised from stable to negative.
On February 19, 2009, Fitch lowered PFI‘s long-term senior debt rating to ―BBB‖ from ―A-‖ and the short-
term rating to ―F2‖ from ―F1.‖ Fitch also downgraded PICA‘s financial strength rating to ―A+‖ from ―AA-‖
and the short-term rating of PF to ―F1‖ from ―F1+.‖ The outlook for all ratings remains negative.
On February 26, 2009, S&P lowered the financial strength ratings of PICA to ―AA-‖ from ―AA‖ and
affirmed PFI‘s long-term senior debt ratings as ―A.‖ The outlook for both ratings was revised from negative to
stable.
On March 18, 2009 Moody‘s lowered PICA‘s financial strength ratings to ―A2‖ from ―Aa3‖ and lowered
the long-term ratings senior debt rating of PFI to ―Baa2‖ from ―A3.‖ The outlook on these ratings remains
negative. Moody‘s also placed the short-term rating of Prudential Funding, LLC on review for possible
downgrade.
On May 27, 2009, A.M. Best Co. affirmed PICA‘s financial strength rating at ―A+‖ and revised the outlook
on that rating to negative from stable.
Recent Developments
TARP Capital Purchase Program
PFI applied in October 2008 to participate in the U.S. Treasury‘s Capital Purchase Program, which is part
of the Troubled Asset Relief Program (TARP). The Capital Purchase Program involves the issuance by
qualifying institutions of preferred stock and warrants to purchase common stock to the U.S. Treasury. On May
14, 2009, PFI received preliminary approval from the U.S. Treasury to participate in the Capital Purchase
Program. However, PFI has determined that it will not participate in the Capital Purchase Program.
Liquidity of PICA
As of March 31, 2009, PICA reported, on a statutory basis, cash, cash equivalents and short term
investments totaling $5.6 billion. Prudential Funding, LLC, a wholly-owned subsidiary of PICA (―PF‖), had
outstanding commercial paper and master note borrowings of $2.6 billion as of March 31, 2009, including
approximately $1.7 billion to fund operating needs as of that date. PF is qualified to participate in the Federal
Reserve Bank of New York‘s Commercial Paper Funding Facility (―CPFF‖) and is eligible to sell to the CPFF
commercial paper up to a maximum amount of $9.8 billion, less the outstanding amount of any non-CPFF
commercial paper. PICA also has access to collateralized borrowings from the Federal Home Loan Bank of
New York, incremental securities lending and repurchase capacity with $19 billion of securities estimated to be
readily lendable as of March 31, 2009 across all of our domestic insurance subsidiaries, and shared access with
PFI to $4.3 billion of committed credit lines.
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Risk Based Capital Sensitivities
The Risk Based Capital (―RBC‖) ratio is a primary measure by which PICA evaluates its capital adequacy.
RBC is determined by statutory guidelines and formulas that consider, among other things, risks related to the
type and quality of the invested assets, insurance-related risks associated with an insurer‘s products and
liabilities, interest rate risks and general business risks. The RBC ratio calculations are intended to assist
insurance regulators in measuring the adequacy of an insurer‘s statutory capitalization. The reporting of RBC
measures is not intended for the purpose of ranking any insurance company or for use in connection with any
marketing, advertising or promotional activities. PICA reported an RBC ratio of 452% as of December 31, 2008.
The RBC ratio is an annual calculation; however, based upon a hypothetical calculation, PICA estimates
that its RBC ratio would exceed 400% as of March 31, 2009.
PICA‘s management estimates that under a stress scenario analysis as of April 30, 2009 assuming a close
of the Standard & Poor‘s 500 Index* at a level of 700 as of December 31, 2009, and assuming investment
portfolio credit losses and impairments amounting to 2.0% of the fixed income investments of PICA and its
insurance subsidiaries, or $2.8 billion, for 2009, PICA would report an RBC ratio in excess of 350% at that date,
after the use of actions that management believes would be available to the company, other than the expected
gain on PICA‘s investment in the Wachovia Securities joint venture.
PICA‘s management estimates that under a stress scenario analysis as of April 30, 2009 assuming a close
of the Standard & Poor‘s 500 Index at a level of 600 as of December 31, 2009, and assuming investment
portfolio credit losses and impairments amounting to 1.4% of the fixed income investments of PICA and its
insurance subsidiaries, or $2.0 billion, for 2009, PICA would report an RBC ratio in excess of 350% at that date,
after the use of actions that management believes would be available to the company, other than the expected
gain on PICA‘s investment in the Wachovia Securities joint venture.
PICA‘s management estimates that under a stress scenario analysis as of April 30, 2009 assuming a close
of the Standard & Poor‘s 500 Index at a level of 600 as of December 31, 2009, and assuming investment
portfolio credit losses and impairments amounting to 2.0% of the fixed income investments of PICA and its
insurance subsidiaries, or $2.8 billion, for 2009, PICA would report an RBC ratio in excess of 300% at that date,
after the use of actions that management believes would be available to the company, other than the expected
gain on PICA‘s investment in the Wachovia Securities joint venture.
The estimated RBC ratios under each of the foregoing stress scenarios assumes credit migration in 2009,
mainly in sub-prime asset-backed securities, resulting in additional reported statutory capital requirements, used
in the denominator for calculating RBC, of about $250 million.
PICA‘s management estimates that under a stress scenario analysis as of April 30, 2009 assuming a close
of the Standard & Poor‘s 500 Index at a level of 600 as of December 31, 2009 and as of December 31, 2010, and
assuming a total of $4.3 billion of investment portfolio fixed income credit losses and impairments for PICA and
its insurance subsidiaries, and credit migration resulting in additional reported statutory capital requirements,
used in the denominator for calculating RBC, of about $350 million, for 2009 and 2010, PICA would report an
RBC ratio in excess of 300% at December 31, 2010, after the use of actions that management believes would be
available to the company, including the expected gain on PICA‘s investment in the Wachovia Securities joint
venture.
In each of the foregoing stress scenarios, assumed investment portfolio credit losses and impairments have
been applied to the fixed income investments of PICA and its insurance subsidiaries, including bonds (other
than securities issued by the U.S. government and its agencies) and mortgage loans.
Some of the potential actions assumed in estimating the RBC ratios to be reported by PICA under the
foregoing stress scenarios require regulatory approval and/or the agreement of counterparties, which are outside
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of PICA‘s control, or have economic costs associated with them, and it is possible that management would
choose not to pursue them in light of the expected gain on PICA‘s investment in the Wachovia Securities joint
venture or for other reasons. In addition, interest rate and equity market fluctuations materially impact the
contribution of some of these potential actions to the RBC ratios to be reported by PICA.
__________________________
*The S&P 500® Index is a registered trademark of Standard & Poor‘s, a division of the McGraw-Hill
Companies, Inc., which is the owner of all copyrights relating to this index and the source of the performance
statistics of this index that are referred to in this report.
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RISK FACTORS
Investors should carefully consider the following factors and other information in this Offering Circular
before deciding to invest in the Notes. The following is not intended as, and should not be construed as, an
exhaustive list of relevant factors.
Risk Factors Relating to the Notes
The Notes are non-recourse obligations of the Issuer.
The obligations of the Issuer to make payments to the Holders of the Notes under the Notes and the
Indenture are payable only from the relevant Trust Estate. If any Event of Default shall occur under any Series
of the Notes, the right of the Holders of such Series, the relevant Series Agent and the Indenture Trustee on
behalf of such Holders will be limited to a proceeding against the relevant Trust Estate (including the exercise of
the Collateral Management Rights (as defined in the Indenture) relating to the Notes) for such Series of Notes
and none of such Holders or the Series Agent or Indenture Trustee on behalf of such Holders will have the right
to proceed against the Trust Estate of any other Series of Notes or the Non-Recourse Parties (as defined in the
―Terms and Conditions of the Notes‖ in this Offering Circular) in the case of any deficiency judgment
remaining after foreclosure of any property included in such Trust Estate. All claims of the Holders of a Series
of Notes in excess of amounts received by the relevant Series of the Issuer under the related Funding
Agreement(s) and the related Trust Estate will be extinguished.
Payments under Funding Agreements may be insufficient to pay principal and interest under the Notes.
Payments of the principal of and interest on a Series of Notes will be made solely from the payments by
PICA under the relevant Funding Agreement(s). PICA will agree pursuant to each Funding Agreement to pay to
the Issuer, subject to certain exceptions set out in full in the Terms and Conditions, Additional Amounts, to
compensate for any withholding or deduction for or on account of any present or future taxes, duties, levies,
assessments or governmental charges of whatever nature imposed or levied on payments in respect of the
relevant Funding Agreement or the related Notes by or on behalf of any governmental authority in the United
States having the power to tax, so that the amount received by the Issuer under the relevant Funding Agreement
and by the Holders of the related Notes after giving effect to such withholding or deduction, whether or not
currently payable, will equal the amount that would have been received under the relevant Funding Agreement
and the related Notes were no such deduction or withholding required.
PICA will also agree to pay, pursuant to a Support and Expenses Agreement entered into in connection
with each Tranche of Notes, any and all of the costs, losses, damages, claims, actions, suits, expenses (including
reasonable fees and expenses of counsel), disbursements, taxes, penalties and liabilities of any kind or nature
whatsoever of the Issuer (collectively, the ―Support Obligations‖), provided that Support Obligations shall not
include (i) any obligation of the Issuer to make any payment to any Holder (as defined in the relevant Support
and Expenses Agreement) in accordance with the terms of the Designated Notes (as defined in the relevant
Support and Expenses Agreement); (ii) any obligation or expense of the Issuer to the extent such obligation or
expense has actually been paid utilizing funds available to the Issuer from payments under the relevant Funding
Agreement; (iii) any cost, loss, damage, claim, action, suit, expense, disbursement, tax, penalty and liability of
any kind or nature whatsoever resulting from or relating to any insurance regulatory or other governmental
authority asserting that: (a) the Designated Notes are, or are deemed to be, (1) participations in the Funding
Agreements or (2) contracts of insurance; or (b) the offer, purchase, sale and/or transfer of the Designated Notes
(1) constitute the conduct of the business of insurance or reinsurance in any jurisdiction or (2) require the Issuer,
any Dealer or any Holder of the Designated Notes to be licensed as an insurer, insurance agent or broker in any
jurisdiction; (iv) any obligation of the Issuer to indemnify PICA or any of its Affiliates; (v) any obligation of
PICA to pay any Additional Amounts pursuant to the terms of the relevant Funding Agreement; and (vi) any
cost, loss, damage, claim, action, suit, expense, disbursement, tax, penalty and liability of any kind or nature
A-39
whatsoever resulting from or relating to (1) fraud, gross negligence or willful misconduct of the Issuer, (2) a
breach of the relevant Support and Expenses Agreement by the Issuer and (3) the acts or failures to act of any
Service Provider (as defined in the Support and Expenses Agreement) to the extent that such Service Provider
would not be entitled to indemnification or payment from the Issuer in connection with any such act or failure to
act pursuant to the terms of any arrangements between the Issuer and such Service Provider in effect on the date
of the relevant Support and Expenses Agreement; provided, however, with respect to the Support Obligations
due to any of the Beneficial Owner, the Delaware Trustee, the Administrator and the Custodian (as defined in
the Support and Expenses Agreement), Support Obligations shall not include clauses (i), (ii), (iv), (v) and (vi)(3)
provided above and any Unanticipated Expenses (as defined in the Indenture) related to any operating,
administrative or similar expenses of the Beneficial Owner, the Delaware Trustee, the Custodian or the
Administrator. The subrogation rights of PICA under each relevant Support and Expenses Agreement and any
amounts relating thereto will not be included in the Trust Estate for the relevant Series of Notes. To the extent
that the Issuer or any Series of the Issuer thereof incurs costs, losses, damages, claims, actions, suits, expenses,
disbursements, taxes, penalties and/or liabilities that are not indemnified by PICA, the ability of the Issuer and
any such Series of the Issuer to make payments under the Notes may be impaired.
Intervening creditors may dilute security interests.
The Issuer's estate, right, title and interest in and to all Funding Agreements entered into in connection with
Tranches of the same Series of Notes, and each Support and Expenses Agreement for such Tranches, will be
included in the Trust Estate in which the Issuer grants a security interest to the relevant Series Agent for the
benefit and security of the Secured Parties. Therefore, Holders of Notes of the first Tranche of Notes of a Series
will have a security interest in each Funding Agreement issued in connection with the first and any subsequent
Tranches of the same Series, if any, and the relevant Support and Expenses Agreement (subject to the
subrogation rights of PICA set forth in the relevant Support and Expenses Agreement). Holders of Notes of
subsequent Tranches of a Series, if any, will have a security interest in the underlying Funding Agreement, and
each Support and Expenses Agreement relating to that particular Tranche and all other Funding Agreements
previously entered into in connection with earlier Tranches of the same Series or subsequently purchased with
respect to subsequent Tranches of the same Series, if any, and the relevant Support and Expenses Agreement
(subject to the subrogation rights of PICA set forth in the relevant Support and Expenses Agreement). No Series
of Notes will have any security or other interest in a Trust Estate, including the Funding Agreements and the
Support and Expenses Agreement included therein, related to any other Series of Notes.
Accordingly, because each Tranche of Notes of a Series will share the security interest of the Series Agent
for such Series in each Funding Agreement, and the Support and Expenses Agreement for that Series, Holders
of Notes of an earlier Tranche may have their security interest in a Funding Agreement, and Support and
Expenses Agreement relating to such earlier Tranche diluted by the issuance of a later Tranche if a lien creditor
or other creditor obtains a lien or security interest on a Funding Agreement and Support and Expenses
Agreement relating to such later Tranche, which lien or security interest is junior to the security interest for the
benefit of the Holders of the earlier Tranche of Notes but may be senior to the security interest for the benefit of
the Holders of the new Tranche of Notes.
If an event of default occurs under the Notes, amounts collected will be used to satisfy certain expenses prior to payments of amounts due under the Notes.
Any money collected by the Indenture Trustee and Series Agents following an Event of Default, and any
monies that may then be held or thereafter received by the Indenture Trustee as security with respect to the
Notes or Coupons of any Series of Notes in the Collection Account (as defined in the Indenture) relating to such
Series of Notes will be applied first to the payment of Anticipated Expenses with respect to such Series due to
the Indenture Trustee and the relevant Series Agent and then to the payment of remaining Anticipated Expenses
with respect to such Series of the Issuer (all the foregoing payments, the ―Priority Payments‖). The monies
will next be applied toward the payment of Accelerated Unanticipated Expenses (as defined in this Offering
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Circular). Any remaining balance thereafter will next be applied to the payment of the amounts then due and
unpaid upon the Notes and any Coupons of such Series for the principal and any premium, interest and
Additional Amounts in respect of which or for the benefit of which such amount has been collected, ratably,
without preference or priority of any kind, according to the aggregate amounts due and payable on such Notes
and Coupons for principal and any premium, interest and Additional Amounts. The remaining monies will be
applied to the payment of all Unanticipated Expenses of the Issuer with respect to such Series. The amounts
remaining after the payment of such Priority Payments and Accelerated Unanticipated Expenses may be
insufficient to satisfy, or satisfy in full, the payment obligations the Issuer has to the Holders of a Series of Notes
under the Terms and Conditions following the occurrence of an Event of Default.
The Notes have a limited liquidity.
Application has been made to the Irish Stock Exchange for the Notes issued under the Program during
the twelve months from the date of this Offering Circular to be admitted to the Official List and trading on
its Regulated Market, and copies of documents in relation to such Notes will be filed with the Irish
Financial Services Regulatory Authority and are expected to be approved for the purpose of the Prospectus
Directive. However, Notes may also be (i) listed on any other Regulated Market, (ii) listed on a securities
exchange which is not a Regulated Market, or (iii) not listed on any Regulated Market or any other
securities exchange. There is currently no secondary market for the Notes. The Dealer(s) are under no
obligation to make a market in the Notes, and to the extent that such market making is commenced, it ma y
be discontinued at any time. There is no assurance that a secondary market will develop or, if it does
develop, that it will provide Holders of the Notes with liquidity of investment or that it will continue for
any period of time. The Notes have not been and will not be registered under the Securities Act or any state
or foreign securities law and transfers of Notes are subject to substantial transfer restrictions. See ―Notice
to Investors‖ and ―Subscription and Sale‖ in this Offering Circular. A Holder of Notes may not be able to
liquidate its investment readily, and the Notes may not be readily accepted as collateral for loans. It is
likely that if the Notes were to be deemed to be contracts of insurance (see ―Notes could be deemed to be
participations in the Funding Agreements or could otherwise be deemed to be contracts of insurance‖
below), the ability of a Holder to offer, sell or transfer the Notes in secondary market transactions or
otherwise would be substantially impaired and, to the extent any such sale or transfer could be effected, the
proceeds realized from such sale or transfer could be materially and adversely affected. Investors should
proceed on the assumption that they may have to hold the Notes until their maturity.
Holders of Notes Below Certain Specified Denominations May Not Be Able to Receive Definitive Notes and in
Such Situations May Not Be Entitled to the Rights in Respect of Such Notes.
Any Notes admitted to the Official List and to trading on the Regulated Market of the Irish Stock Exchange
or any other Regulated Market, or which are to be offered to the public in any Member State of the European
Economic Area in circumstances which require the publication of a prospectus under the Prospectus Directive,
will be issued in specified denominations of €50,000 or greater (or the equivalent thereof in another currency at
the time of issue) (the ―Specified Denominations‖). The applicable Final Terms may provide that, for so long as
the Notes are represented by a Global Note and Euroclear and Clearstream Luxembourg so permit, the Notes
may be tradeable in specified denominations of €50,000 and integral multiples of €1,000 thereafter (or the
equivalent thereof in another currency at the time of issue), although if a Global Registered Note is exchanged
for Definitive Registered Notes, at the option of the relevant holder, the notes shall be tradeable only in principal
amounts of at least €50,000. In these circumstances, a holder of Notes holding Notes having a nominal amount
which cannot be represented by a definitive Note in the Specified Denomination will not be able to receive a
definitive Note in respect of such Notes and will not be able to receive interest or principal or be entitled to vote
in respect of such Notes. As a result, a holder of Notes who holds Notes in Euroclear or Clearstream
Luxembourg in an amount less than the Specified Denominations may need to purchase or sell, on or before the
relevant date on which the Regulation S Temporary Global Note or Regulation S Permanent Global Note are to
A-41
be exchanged for definitive Notes, a principal amount of Notes such that the holders hold the Notes in an
aggregate principal amount of at least the Specified Denominations.
The Notes could be deemed to be participations in the Funding Agreements or could otherwise be deemed to be contracts of insurance.
The laws and regulations of each state of the United States and of foreign jurisdictions contain broad
definitions of the activities that may constitute the conduct of the business of insurance or reinsurance in such
jurisdictions.
D&L, special counsel for PICA, has advised, in a letter dated April 22, 2009, with regard to insurance
matters that neither the Issuer nor any persons selling or purchasing the Notes should be subject to regulation as
doing an insurance business in any state of the United States or the District of Columbia by virtue of the offer,
sale and/or purchase of the Notes. This advice is based upon interpretations (either written or oral) received as of
specified dates from the staff of the insurance regulatory body in each of the states of the United States (except
the states of Florida, Iowa, Mississippi, Montana, New Mexico and Vermont, where the Issuer obtained opinions
of local counsel as of specified dates) and is subject to the considerations described below. These interpretations
from insurance regulatory bodies and local counsel were obtained in connection with structures which raise
some of the same issues as those presented by the Notes. These oral and written interpretations from state
insurance regulatory bodies, some of which date back to 2000, were based on general descriptions of the
issuance of funding agreements to back instruments such as the Notes and were not specifically based on the
Program or the Notes. Information specifically relating to the Program and/or the Notes which was not
disclosed to insurance regulators could be considered material by such regulators and, had such factual
information been disclosed, could have resulted in different guidance or advice from such regulators. Based on
these oral and written interpretations and local counsel opinions and subject to such other considerations as are
set forth in its letter, D&L believes that (i) the Notes should not be subject to regulation as participations in the
Funding Agreements themselves or otherwise constitute insurance contracts and (ii) the Issuer and persons
offering, selling or purchasing the Notes should not be subject to regulation as doing an insurance business by
virtue of their activities in connection with the offer, sale and/or purchase of the Notes.
The staff of the Arkansas Insurance Department has stated that it would not encourage any Arkansas
domestic insurer to purchase investment products such as the Notes. In addition, the Indiana Insurance
Department has stated that Indiana domestic insurers should contact the Indiana Insurance Department before
purchasing any instruments such as the Notes.
All written or oral communications with insurance regulatory bodies reflect only the interpretation of the
staff of such regulatory bodies with respect to the laws and regulations of their respective jurisdictions, and do
not purport to be, nor should they be relied upon as, binding legal authority. Such interpretations and advice by
local counsel may be subject to challenge in administrative or judicial proceedings.
Insurance regulatory authorities in the United States have broad discretionary powers to modify or
withdraw regulatory interpretations, and such interpretations and the advice of counsel received with respect to
the laws of any particular state are not binding on a court or any third party and may be subject to challenge in
administrative or judicial proceedings. In addition, such interpretations have not been obtained with respect to
any foreign jurisdictions. There can be no assurance that such interpretations and advice will remain in effect,
or that such interpretations would be given any effect by a court.
The Issuer will not be registered or licensed as an insurance or reinsurance company in any jurisdiction. In
the event it is determined that the Issuer should have been licensed under the insurance laws of a jurisdiction in
connection with the issuance of the Notes, the Issuer will be in violation of such laws or regulations and could
be subject to the fines, penalties and other sanctions provided for therein. Such violation would have a material
adverse impact on the Issuer's ability to meet its obligations under the Notes.
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Similarly, if the Notes are deemed to be subject to regulation as participations in Funding Agreements or
otherwise constitute contracts of insurance, there can be no assurance that Holders of the Notes who
subsequently offer, sell, transfer or purchase Notes could not be found to be acting as insurance agents or
brokers under the laws of certain jurisdictions or otherwise be subject to the applicable insurance laws. Acting
without a required insurance agent or broker license or other violations of applicable insurance laws and
regulations could subject such Holder of Notes to substantial civil and criminal fines and charges.
It is likely that if the Notes were to be deemed to be subject to regulation as participations in Funding
Agreements or otherwise constitute contracts of insurance, the ability of a Holder to offer, sell or otherwise
transfer the Notes in secondary market transactions or otherwise would be substantially impaired and, to the
extent such offer, sale or transfer could be effected, the proceeds realized from such offer, sale or transfer would
be materially and adversely affected.
Certain Holders of Notes will not be entitled to the payment of additional amounts and the Notes of a Series may be redeemed upon the occurrence of certain tax events.
The Issuer and PICA are not required to pay Additional Amounts to Holders of Notes to compensate for
any withholding or deduction for taxes imposed by or on behalf of any governmental authority in the United
States having the power to tax, unless such Holder meets certain requirements. For example, a Holder of Notes
that is not a United States person (as defined in Section 7701(a)(30) of the Code) and actually or constructively
owns ten percent or more of the total combined voting power of all classes of stock of PICA entitled to vote
would not be entitled to the payment of Additional Amounts as a result of the imposition of any United States
withholding tax.
The Issuer is required to redeem the Notes of the relevant Series as provided in this Offering Circular if
PICA exercises its right to terminate any Funding Agreement related to such Series upon the occurrence of
certain tax events, including, without limitation, if PICA is required to pay Additional Amounts or withhold or
deduct any United States taxes as a result of a change or amendment in any United States tax laws.
An investment in Foreign Currency Notes entails significant risks.
An investment in Notes that are denominated in, or the payment of which is related to the value of, a
specified currency (the ―Specified Currency‖) other than the currency of the country in which the purchaser is
a resident or the currency (including any composite currency) in which the purchaser conducts its business or
activities (the ―Home Currency‖) entails significant risks that are not associated with a similar investment in a
security denominated in the Home Currency. Such risks include, without limitation, the possibility of
significant changes in rates of exchange between the Home Currency and the various foreign currencies (or
composite currencies) and the possibility of the imposition or modification of exchange controls by either the
United States or foreign governments. Such risks generally depend on economic and political events over which
none of the Issuer, PICA or any Dealer has control. In recent years rates of exchange for certain currencies have
been highly volatile and such volatility may be expected to continue in the future. Fluctuations in any particular
exchange rate that have occurred in the past are not necessarily indicative, however, of fluctuations in such rate
that may occur during the term of any Note. Depreciation of the Specified Currency for a Note against the
relevant Home Currency would result in a decrease in the effective yield of such Note below its coupon rate and,
in certain circumstances, could result in a loss to the investor on a Home Currency basis.
Foreign exchange rates can either float or be fixed by sovereign governments. Exchange rates of most
economically developed nations are permitted to fluctuate in value relative to the U.S. Dollar. National
governments, however, rarely voluntarily allow their currencies to float freely in response to economic forces.
From time to time governments use a variety of techniques, such as intervention by a country's central bank or
A-43
imposition of regulatory controls or taxes, to affect the exchange rates of their currencies. Governments may
also issue a new currency to replace an existing currency or alter the exchange rates or relative exchange
characteristics by devaluation or revaluation of a currency. Thus, a special risk in purchasing non-Home
Currency-denominated Notes is that their Home-Currency-equivalent yields or payouts could be affected by
governmental actions which could change or interfere with theretofore freely determined currency valuation,
fluctuations in response to other market forces, and the movement of currencies across borders. There will be
no adjustment or change in the terms of such Notes in the event that exchange rates should become fixed, or in
the event of any devaluation or revaluation or imposition of exchange or other regulatory controls or taxes, or in
the event of other developments affecting the U.S. Dollar or any applicable Specified Currency.
Governments have imposed from time to time, and may in the future impose, exchange controls that could
affect exchange rates as well as the availability of a specified foreign currency (or of securities denominated in
such currency). Even if there are no actual exchange controls, it is possible that the Specified Currency for any
particular Note not denominated in U.S. Dollars would not be available when payments on such Note are due.
In that event, the Issuer would make required payments in U.S. Dollars on the basis of the market rate of
exchange on the date of such payment or, if such rate of exchange is not then available, on the basis of the
market rate of exchange as of the most recent practicable date.
Each prospective investor should consult its own financial, legal and tax advisors as to any specific risks
entailed by an investment by such investor in Notes that are denominated in, or the payment of which is related
to the value of, a currency other than such prospective investor's Home Currency. Such Notes are not an
appropriate investment for investors who are unsophisticated with respect to foreign currency transactions.
An investment in Indexed Notes entails significant risks.
Notes may be issued with the principal amount payable at maturity or interest to be paid thereon, or both, to
be determined with reference to the price or prices of specified commodities or stocks, the exchange rate of one
or more currencies (including a composite currency) relative to one or more other currencies (including a
composite currency), or such other price or exchange rate as may be specified in such Notes (―Indexed Notes‖),
as set forth in the relevant Final Terms. An investment in Indexed Notes entails significant risks that are not
associated with similar investments in a conventional fixed-rate debt security. If the interest rate of an Indexed
Note is indexed, it may result in an interest rate that is less than that payable on a conventional fixed-rate debt
security issued by the Issuer at the same time, including the possibility that no interest will be paid, and, if the
principal amount of an Indexed Note is indexed, the principal amount payable at maturity may be less than the
original purchase price of such Indexed Note, including the possibility that no principal will be paid out (but in
no event shall the amount of interest or principal paid with respect to an Indexed Note be less than zero). The
secondary market for Indexed Notes will be affected by a number of factors, independent of the creditworthiness
of the Issuer or PICA, as the case may be, and the value of the applicable currency, commodity or interest rate
index, including but not limited to, the volatility of the applicable currency or interest rate index, the time
remaining to the maturity of such Indexed Notes, the amount outstanding of such Indexed Notes and market
interest rates. The value of the applicable currency, commodity or interest rate index depends on a number of
interrelated factors, including economic, financial and political events, over which the Issuer does not have
control. Additionally, if the formula used to determine the principal amount or interest payable with respect to
such Indexed Notes contains a multiple or leverage factor, the effect of any change in the applicable currency,
commodity or interest rate index may be increased. The historical experience of the relevant currencies,
commodities or interest rate indices should not be taken as an indication of future performance of such
currencies, commodities or interest rate indices during the term of any Indexed Note. Accordingly, prospective
investors should consult their own financial and legal advisors as to the risks entailed by an investment in
Indexed Notes and the suitability of Indexed Notes in light of their particular circumstances.
A-44
Risk Factors Related to the Issuer
The Issuer has limited resources and limited business purpose.
The net worth of the Issuer on the date hereof is approximately $1,000. The net worth of the Issuer is not
expected to increase materially. The ability of the Issuer, with respect to each Series of the Issuer, to make
timely payments on the Notes of such Series is entirely dependent upon PICA‘s making the related payments
under the relevant Funding Agreements in a timely manner and on PICA‘s fulfilling its obligations under the
applicable Support and Expenses Agreements. The Issuer is a statutory trust formed on July 10, 2002 under the
laws of the State of Delaware, the primary business purpose of which is the issuance of the Notes in Series, the
purchase of the related Funding Agreements and engaging in activities incidental thereto.
The obligations of the Issuer evidenced by the Notes will not be obligations of, and will not be guaranteed
by, any person, including, but not limited to, PICA, PH, PFI or any of their respective subsidiaries or affiliates.
None of these entities nor any agent, trustee or beneficial owner of the Issuer or of any Series of the Issuer is
under any obligation to provide funds or capital to the Issuer or such Series, other than pursuant to the Funding
Agreements and the Support and Expense Agreements.
The Notes are issued in Series.
The Issuer is a statutory trust organized in series, and the debts, liabilities, obligations and expenses
incurred, contracted for or otherwise existing with respect to each Series of the Issuer shall be enforceable
against only the assets of the relevant Series of the Issuer and not against the assets of the Issuer generally or the
assets related to any other Series of the Issuer, except with respect to the Accelerated Unanticipated Expenses
(as defined below) which shall be applied pro rata to each outstanding Series. Each Series of Notes will be
secured by, among other things, one or more separate Funding Agreements and one or more Support and
Expenses Agreements for each Tranche of such Series (subject to the subrogation rights of PICA set forth in the
relevant Support and Expenses Agreements). No Series of Notes will have any right to receive payments under
a Funding Agreement or a Support and Expenses Agreement, as the case may be, related to any other Series of
Notes.
Risk Factors Relating to Collateral
The status of collateral upon insolvency of PICA and possible equitable subordination.
The Funding Agreements and the Support and Expenses Agreements are unsecured obligations of PICA
and, in the event of PICA‘s insolvency, will be subject to the provisions of Section 17B:32-71 of the Liquidation
Act, which establishes the priority of claims from the estate of an insolvent New Jersey stock life insurance
company. D&L, special counsel for PICA, has opined to the Issuer, PICA and the Dealers that in any
liquidation proceeding relating to PICA, under New Jersey law as in effect on the date of this Offering Circular,
(i) the claims under each Funding Agreement should rank (a) pari passu with the claims of policyholders of
PICA and in a superior position to the claims of general creditors of PICA with respect to scheduled payments
of principal and interest under the Funding Agreement and (b) pari passu with the claims of general creditors of
PICA with respect to any payment of Additional Amounts under the Funding Agreement and (ii) the claims
under the Support and Expenses Agreements should rank pari passu with the claims of general creditors of
PICA. As such counsel has noted, however, a court could equitably subordinate any claim, including a claim
under the Funding Agreements, to a lower level of priority if it determines that such claim was unfairly or
fraudulently obtained. In addition, such opinion of counsel with respect to the priority of claims under each
Funding Agreement relies in part on the reasoning of an unpublished decision of the New Jersey Superior Court,
Chancery Division, a lower level court, and such counsel has noted that until such decision is officially
published (if ever), the decision cannot be cited by any other New Jersey court as precedent. Such counsel has
assumed for purposes of rendering its opinion that a New Jersey court would consider the aforementioned
A-45
unpublished lower level court decision and treat such unpublished decision as persuasive authority.
Furthermore, such opinion of counsel is based upon certain facts, assumptions and qualifications (as set forth
therein), is only an opinion, does not constitute a guarantee, and is not binding upon any court, including without
limitation a court presiding over a liquidation proceeding of PICA under the Liquidation Act.
Claims under the Funding Agreements and claims under the Support and Expenses Agreements will not be
covered by the New Jersey Life and Health Insurance Guaranty Association. The obligations of PICA under the
Funding Agreements and the Support and Expenses Agreements will not be obligations of, and will not be
guaranteed by, any person.
Risk Factors Relating to PICA, as Provider of the Funding Agreements and as Provider of Certain
Indemnities under the Support and Expenses Agreements.
Current difficult conditions in the global financial markets and the economy generally could materially
adversely affect PICA‘s businesses, results of operations or financial condition or cause its actual results to
differ materially from those expected or those expressed in any forward looking statements made by or on
behalf PICA. These risks are not exclusive, and additional risks to which PICA is subject include, but are not
limited to, the factors mentioned under ―Forward-Looking Statements‖ and the risks described elsewhere in this
Offering Circular. Within this section regarding risk factors relating to PICA, references to ―PICA‖ shall mean
PICA and its consolidated subsidiaries, unless the context otherwise requires.
PICA’s results of operations have been materially adversely affected by conditions in the global financial
markets and the economy generally. PICA businesses, results of operations and financial condition may be
further adversely affected, possibly materially, if these conditions persist or deteriorate.
The stress experienced by global financial markets that began in the second half of 2007 has continued
and substantially increased since then. The volatility and disruption in the global financial markets have reached
unprecedented levels in the post World War II period. The availability and cost of credit has been materially
affected. These factors, combined with economic conditions in the U.S. including depressed home and
commercial real estate prices and increasing foreclosures, falling equity market values, declining business and
consumer confidence and rising unemployment, have precipitated a severe economic recession and fears of even
more severe and prolonged adverse economic conditions.
Due to the economic environment, the global fixed-income markets are experiencing a period of both
extreme volatility and limited market liquidity conditions, which has affected a broad range of asset classes and
sectors. As a result, the market for fixed income instruments has experienced decreased liquidity, increased price
volatility, credit downgrade events, and increased probability of default. Global equity markets have also been
experiencing heightened volatility. These events and the continuing market upheavals have had and may
continue to have an adverse effect on PICA and its affiliates. PICA‘s revenues are likely to decline in such
circumstances, the cost of meeting its obligations to customers may increase, and PICA‘s profit margins would
likely erode. In addition, in the event of a prolonged or severe economic downturn, PICA could incur significant
losses in its investment portfolio.
The demand for PICA’s products could be adversely affected in an economic downturn
characterized by higher unemployment, lower family income, lower consumer spending, lower corporate
earnings and lower business investment. PICA also may experience a higher incidence of claims and
lapses or surrenders of policies. PICA’s policyholders may choose to defer or stop paying insurance
premiums. PICA cannot predict definitively whether or when such actions, which could impact PICA’s
business, results of operations, cash flows and financial condition, may occur.
A-46
Markets in the United States and elsewhere have experienced extreme and unprecedented volatility and
disruption, with adverse consequences to PICA’s liquidity, access to capital and cost of capital. A
continuation or deterioration in these conditions may significantly affect PICA’s ability to meet liquidity
needs, its access to capital and its cost of capital. PICA and its affiliates may seek to raise additional capital
in the debt or equity markets but be unable to obtain such capital.
Adverse capital market conditions have affected and may continue to affect the availability and cost of
borrowed funds and could impact PICA‘s ability to refinance existing borrowings, thereby ultimately impacting
its profitability and ability to support or grow its businesses. PICA and its affiliates need liquidity to pay
operating expenses, interest on their debt and replace certain maturing debt obligations. Without sufficient
liquidity, PICA could be forced to curtail certain of its operations, and its business could suffer. The principal
sources of PICA‘s liquidity are insurance premiums, annuity considerations, deposit funds and cash flow from
its investment portfolio and assets, consisting mainly of cash or assets that are readily convertible into cash.
Sources of liquidity for PICA and its affiliates in normal markets also include a variety of short- and long-term
instruments, including securities lending and repurchase agreements, commercial paper, medium and long-term
debt and capital securities.
Disruptions, uncertainty or volatility in the financial markets have limited and may be expected to
continue to limit PICA‘s access to capital required to operate its business. These market conditions may limit
PICA‘s and its affiliates‘ ability to replace, in a timely manner, maturing debt obligations and access the capital
necessary to grow their business, replace capital withdrawn by customers or raise new capital. As a result, PICA
and its affiliates may be forced to delay raising capital, issue shorter tenor securities than would be optimal, bear
an unattractive cost of capital or be unable to raise capital at any price, which could decrease their profitability
and significantly reduce their financial flexibility. Given the disruptions in the credit and capital markets, it is
uncertain at this time whether PICA and its affiliates can issue long-term debt at all, or at least at a cost that is
not prohibitive. Actions PICA and its affiliates might take to access financing may in turn cause rating agencies
to reevaluate their ratings. PICA‘s and its affiliates‘ ability to borrow under their commercial paper programs is
also dependent upon market conditions. Future deterioration of PICA‘s capital position at a time when it is
unable to access the long-term debt or commercial paper markets could have a material adverse effect on its
liquidity. PICA‘s internal sources of liquidity may prove to be insufficient.
PICA and its affiliates may seek additional debt or equity financing to satisfy their needs. The
availability of additional financing will depend on a variety of factors such as market conditions, the
general availability of credit, the overall availability of credit to the financial services industry, and their
credit ratings and credit capacity. They may not be able to successfully obtain additional financing on
favorable terms, or at all.
The Risk Based Capital, or RBC, ratio is the primary measure by which PICA evaluates its capital
adequacy, which includes businesses in both the Financial Services Businesses and the Closed Block (each as
defined under ―Business of PICA‖ – ―Demutualization‖) business. PICA has managed its RBC ratio to a level
consistent with a ―AA‖ ratings objective; however, rating agencies take into account a variety of factors in
assigning ratings in addition to RBC levels. RBC is determined by statutory rules that consider risks related to
the type and quality of the invested assets, insurance-related risks associated with PICA‘s products, interest rate
risks and general business risks. The RBC ratio calculations are intended to assist insurance regulators in
measuring the adequacy of PICA‘s statutory capitalization. Subsequent to September 30, 2008 market
conditions negatively impacted PICA‘s total capital and the level of capital in its domestic life insurance
subsidiaries and caused PFI to take capital management actions to maintain PICA‘s capital consistent with these
ratings objectives, which included redeployment of financial resources from internal sources, including the
contribution to PICA of the PFI subsidiary that holds its minority interest in the Wachovia Securities retail
brokerage joint venture. The RBC ratio is an annual calculation; however, based upon March 31, 2009 amounts,
PICA‘s RBC would exceed the minimum level required by applicable insurance regulations. The level of
PICA‘s statutory capital is affected by the statutory accounting rules for loan-backed and structured securities.
Mandatory adoption of changes to these rules was recently deferred until periods ending on or after September
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30, 2009. Further changes to these rules by insurance regulators, or the timing of PICA‘s application of these
rules, are possible, given the deferral and other uncertainty around the resolution of these accounting rules.
A continuation or worsening of the disruptions in the credit and capital markets could adversely affect
PICA‘s and its affiliates‘ ability to access sources of liquidity, as well as threaten to reduce PICA‘s capital
below a level that is consistent with its existing ratings objectives. Therefore, PICA and its affiliates may need to
take additional actions, which may include but are not limited to: (1) undertake additional capital management
activities, including recapture of liabilities previously ceded to our off-shore captive reinsurance subsidiary
and/or reinsurance transactions; (2) access to alternative sources of liquidity; (3) access to external sources of
capital, including the debt markets, or equity markets through Prudential Financial, Inc. (―PFI‖); (4) utilize
further proceeds from our outstanding retail medium-term notes for general corporate purposes by accelerating
repayments under additional funding agreements; (5) transfer ownership of certain subsidiaries of PFI to PICA;
(6) take additional actions related to derivatives; (7) limiting or curtailing sales of certain products and/or
restructuring existing products; (8) undertaking asset sales; and (9) seeking temporary or permanent changes to
regulatory rules. Certain of these capital management activities may require regulatory approval and/or
agreement of counterparties which are outside of PICA‘s control.
PICA, along with PFI and Prudential Funding, LLC (―PF‖), maintains committed unsecured revolving
credit facilities that, as of March 31, 2009, totaled $4.34 billion. PICA relies on these credit facilities as a
potential source of liquidity which could be critical in enabling PICA to meet its obligations as they come due,
particularly during periods when alternative sources of liquidity are limited such as in the current market
environment. PICA‘s ability to borrow under these facilities is conditioned on the satisfaction of covenants and
other requirements contained in the facilities, such as PICA‘s maintenance of total adjusted capital of at least
$5.5 billion based on statutory accounting principles prescribed under New Jersey law and PFI‘s maintenance of
consolidated net worth of at least $12.5 billion, which for this purpose is based on U.S. GAAP stockholders‘
equity, excluding net unrealized gains and losses on investments. The failure to satisfy these and other
requirements contained in the credit facilities would restrict PICA‘s access to the facilities when needed and,
consequently, could have a material adverse effect on PICA‘s financial condition and results of operations.
PFI‘s asset management operations include real estate held in PICA separate accounts, for the benefit of
clients, which enter into forward commitments which typically are funded from separate account assets and cash
flows and related funding sources. Owing to the adverse credit and capital market conditions, these separate
accounts may have difficulty funding in the normal course commitments due in 2009. In that case, PICA might
be called upon or required to provide interim funding solutions, which could affect the availability of liquidity
for other purposes.
Governmental actions in response to the current financial crisis may not be effective. Participation by PICA
or its affiliates in certain of these governmental programs could result in limitations or restrictions on their
businesses or otherwise restrict their flexibility.
In response to the market dislocation affecting the banking system and financial markets, on October 3,
2008, President Bush signed the Emergency Economic Stabilization Act of 2008, or EESA, into law. Pursuant to
the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-
backed and other securities from financial institutions for the purpose of stabilizing the financial markets. On
October 14, 2008, the U.S. Treasury announced that it would use EESA authority to invest an aggregate of $250
billion (of the first $350 billion released under EESA) in capital issued by qualifying U.S. financial institutions
under the U.S. Treasury‘s Capital Purchase Program, which is part of the Troubled Asset Relief Program, or
TARP. The TARP Capital Purchase Program involves the issuance by qualifying institutions of preferred stock
and warrants to purchase common stock to the U.S. Treasury. Concurrently, in coordination with the U.S.
Treasury, the FDIC announced the Temporary Liquidity Guarantee Program, through which it guarantees
certain newly issued senior unsecured debt issued by FDIC insured institutions and their qualifying holding
companies, as well as funds over $250,000 in non-interest-bearing transaction deposit accounts. In addition,
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since March 2008, the Federal Reserve has created several lending facilities to stabilize financial markets
including the Term Asset-Backed Securities Loan Facility, or TALF. The TALF is designed to provide secured
financing for certain types of asset-backed securities.
On February 10, 2009, the U.S. Treasury announced a Financial Stability Plan to build upon existing
programs and earmark the second $350 billion of funds that were authorized under the EESA and released in
January 2009. The elements of the Financial Stability Plan, as described by the U.S. Treasury, are a Capital
Assistance Program and Financial Stability Trust to make capital available to financial institutions through
additional purchases of preferred stock, a Public-Private Investment Program, or PPIP, to buy legacy loans and
assets from financial institutions, a Consumer and Business Lending Initiative to restart securitization markets
for loans to consumers and businesses by expanding upon TALF, and a comprehensive housing program to,
among other things, help reduce mortgage payments and interest rates. The U.S. Treasury has stated that the
Financial Stability Plan will require high levels of transparency and accountability standards and dividend,
acquisition and executive compensation restrictions for financial institutions that receive government assistance
going forward.
In the first quarter of 2009, the U.S. Treasury, in conjunction with the FDIC and the Federal Reserve,
announced details regarding the PPIP. The PPIP has two separate parts to address the problem of ―legacy assets‖
—real estate loans held directly on the books of banks (―legacy loans‖) and securities backed by loan portfolios
(―legacy securities‖). Under the Legacy Loans Program portion of the PPIP, the U.S. Treasury will invest
alongside private investors in individual investment funds referred to as Public-Private Investment Funds, which
will purchase eligible asset pools from depository institutions on a discrete basis. The FDIC will provide a
guarantee for the debt financing issued by the Public-Private Investment Funds to fund the asset purchases.
Under the Legacy Securities Program, the Federal Reserve will (i) expand TALF to cover additional eligible
assets, including certain non-agency residential mortgage backed securities that were originally rated AAA and
outstanding commercial mortgage backed securities and asset backed securities that are rated AAA and (ii) the
U.S. Treasury will also co-invest with, and provide leverage to, up to five approved assets managers to support
the market for legacy securities originated prior to 2009 with a rating of AAA at the time of origination.
PFI applied in October 2008 to participate in the Capital Purchase Program, and, on May 14, 2009, it
received preliminary approval from the U.S. Treasury to participate in the Capital Purchase Program. However,
PFI has determined that it will not participate in the Capital Purchase Program.
The U.S. federal government has taken or is considering taking other actions to address the financial crisis,
including mortgage and credit card program modification proposals, that could further impact our business and
investments, particularly our mortgage and consumer debt related investments, which are significant. We cannot
predict with any certainty whether these actions will be effective or the effect they may have on the financial
markets or on our business, results of operations, cash flows and financial condition.
Market fluctuations and general economic, market and political conditions may adversely affect PICA’s
business and profitability.
Even under relatively more favorable market conditions (such as those prevailing before the second half of
2007), PICA's insurance products, investment returns and certain of its investment products and its access to and
cost of financing, are sensitive to fixed income, equity, real estate and other market fluctuations and general
economic, market and political conditions. These fluctuations and conditions could adversely affect its results
of operations, financial position and liquidity, including in the following respects:
The profitability of many of PICA‘s insurance products depends in part on the value of the separate
accounts supporting these products, which may fluctuate substantially depending on the foregoing
conditions.
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A change in market conditions, including prolonged periods of high inflation, could cause a change
in consumer sentiment adversely affecting sales and persistency of PICA‘s long-term savings and
protection products. Similarly, changing economic conditions and unfavorable public perception
of financial institutions can influence customer behavior including but not limited to increasing
claims in certain product lines.
Sales of PICA‘s investment-based and asset management products and services may decline and
lapses and surrenders of variable life and annuity products and withdrawals of assets from other
investment products may increase if a market downturn, increased market volatility or other market
conditions result in customers becoming dissatisfied with their investments or products.
A market decline could further result in guaranteed minimum benefits contained in many of
PICA‘s variable annuity products being higher than current account values or its pricing
assumptions would support, requiring it to materially increase reserves for such products and may
cause customers to retain contracts in force in order to benefit from the guarantees, thereby
increasing their cost to PICA. PICA‘s valuation of the liabilities for the minimum benefits
contained in many of its variable annuity products requires it to consider the market perception of
its risk of non-performance; and a decrease in its own credit spreads resulting from ratings
upgrades or other events or market conditions could cause the recorded value of these liabilities to
increase, which in turn could adversely affect its results of operations and financial position.
Market conditions determine the availability and cost of the reinsurance protection PICA
purchases. Accordingly, PICA may be forced to incur additional expenses for reinsurance or may
not be able to obtain sufficient reinsurance on acceptable terms which could adversely affect the
profitability of future business or its willingness to write future business.
Hedging instruments PICA holds to manage foreign exchange, product and other risks might not
perform as intended or expected resulting in higher realized losses and unforeseen cash needs.
Market conditions can limit availability of hedging instruments and also further increase the cost of
executing product related hedges and such costs may not be recovered in the pricing of the
underlying products being hedged. PICA‘s hedging strategies rely on the performance of
counterparties to such hedges. These counterparties may fail to perform for various reasons
resulting in hedge ineffectiveness and higher losses.
PICA has significant investment and derivative portfolios. Adverse capital market conditions,
including but not limited to a lack of buyers in the marketplace, volatility, credit spread changes,
benchmark interest rate changes, and declines in value of underlying collateral will impact the
credit quality, liquidity and value of its investments and derivatives, potentially resulting in higher
capital charges and unrealized or realized losses, the latter especially if PICA needed to sell a
significant amount of investments under such adverse capital market conditions. For example, a
widening of credit spreads, such as the market has experienced recently, increases the net
unrealized loss position of PICA‘s investment portfolio and may ultimately result in increased
realized losses. Values of PICA‘s investments and derivatives can also be impacted by reductions
in price transparency, changes in assumptions or inputs it uses in estimating fair value and changes
in investor confidence and preferences, potentially resulting in higher realized or unrealized losses.
Volatility can make it difficult to value certain of its securities if trading becomes less frequent. As
such, valuations may include assumptions or estimates that may have significant period to period
changes which could have a material adverse effect on its consolidated results of operations or
financial condition.
Regardless of market conditions, certain investments PICA holds, including private bonds and
commercial mortgages, are relatively illiquid. If PICA needed to sell these investments, it might
have difficulty doing so in a timely manner at a price that it could otherwise realize.
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Adverse capital market conditions could affect PICA‘s ability to borrow funds, including issuing
commercial paper, as well as impact its ability to refinance existing borrowings, ultimately
impacting profitability and also its ability to support or grow its business.
Market conditions could also impact PICA‘s ability to fund foreseen and unforeseen cash and
adverse collateral requirements, potentially inhibiting its ability to perform under its counterparty
obligations, support business initiatives and increasing realized losses.
As described above, the adverse market and economic conditions that began in the second half of 2007
have continued and substantially worsened. The foregoing risks are even more pronounced in these
unprecedented market and economic conditions.
Interest rate fluctuations could adversely affect PICA’s businesses and profitability.
PICA‘s insurance products, investment returns and certain of its investment products may be sensitive to
interest rate fluctuations, and changes in interest rates could adversely affect its investment returns and results of
operations, including in the following respects:
Some of its products expose PICA to the risk that changes in interest rates will reduce the spread
between the amounts that PICA is required to pay under the contracts and the rate of return PICA is
able to earn on its general account investments supporting the contracts. When interest rates
decline, PICA has to reinvest the cash income from its investments in lower yielding instruments.
Since many of its policies and contracts have guaranteed minimum interest or crediting rates or
limit the resetting of interest rates, the spreads could decrease and potentially become negative.
When interest rates rise, PICA may not be able to replace the assets in its general account with the
higher yielding assets needed to fund the higher crediting rates necessary to keep these products
and contracts competitive. This risk is heightened in the current market and economic environment,
in which many desired securities are unavailable.
Changes in interest rates may reduce net investment income and thus PICA‘s spread income which
is a portion of its profitability. Changes in interest rates can also result in potential losses in
PICA‘s investment activities in which PICA borrows funds and purchases investments to earn
additional spread income on the borrowed funds.
When interest rates rise, policy loans and surrenders and withdrawals of life insurance policies and
annuity contracts may increase as policyholders seek to buy products with perceived higher returns,
requiring PICA to sell investment assets potentially resulting in realized investment losses.
A decline in interest rates accompanied by unexpected prepayments of certain investments could
result in reduced investments and a decline in PICA‘s profitability. An increase in interest rates
accompanied by unexpected extensions of certain lower yielding investments could result in a
decline in PICA‘s profitability.
Changes in the relationship between long-term and short-term interest rates could adversely affect
the profitability of some of PICA‘s products.
Changes in interest rates could increase PICA‘s costs of financing.
PICA‘s mitigation efforts with respect to interest rate risk are primarily focused on maintaining an
investment portfolio with diversified maturities that has a weighted average duration that is
approximately equal to the duration of its estimated liability cash flow profile. However, there are
practical and capital market limitations on PICA‘s ability to accomplish this and its estimate of the
liability cash flow profile may be inaccurate. Due to these and other factors PICA may need to
liquidate investments prior to maturity at a loss in order to satisfy liabilities or be forced to reinvest
funds in a lower rate environment. Although PICA takes measures to manage the economic risks of
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investing in a changing interest rate environment, PICA may not be able to effectively mitigate the
interest rate risk of its assets relative to its liabilities.
If PICA’s reserves for future policyholder benefits and claims are inadequate, PICA may be required to
increase its reserves, which would adversely affect its results of operations and financial condition.
PICA establishes and carries reserves to pay future policyholder benefits and claims. PICA‘s reserves do
not represent an exact calculation of liability, but rather are actuarial or statistical estimates based on models that
include many assumptions and projections which are inherently uncertain and involve the exercise of significant
judgment, including as to the levels of and/or timing of receipt or payment of premiums, benefits, claims,
expenses, interest credits, investment results (including equity market returns), retirement, mortality, morbidity
and persistency. PICA cannot determine with precision the ultimate amounts that it will pay for, or the timing of
payment of, actual benefits, claims and expenses or whether the assets supporting its policy liabilities, together
with future premiums, will be sufficient for payment of benefits and claims. If PICA concludes that its reserves,
together with future premiums, are insufficient to cover future policy benefits and claims, it would be required
to increase its reserves and incur income statement charges for the period in which it makes the determination,
which would adversely affect its results of operations and financial condition.
For certain of PICA‘s products, market performance and interest rates impact the level of statutory reserves
and statutory capital PICA is required to hold, and may have an adverse effect on returns on capital associated
with these products. For example, equity market declines in the fourth quarter of 2008 caused a significant
increase in the level of statutory reserves and statutory capital PICA is required to hold in relation to its
Individual Annuities business. Capacity for reserve funding structures available in the marketplace is currently
limited as a result of market conditions generally. PICA‘s ability to efficiently manage capital and economic
reserve levels may be impacted, thereby impacting profitability and return on capital.
PICA’s profitability may decline if mortality rates, morbidity rates or persistency rates differ significantly
from its pricing expectations.
PICA sets prices for many of its insurance and annuity products based upon expected claims and payment
patterns, using assumptions for mortality rates, or likelihood of death, and morbidity rates, or likelihood of
sickness, of its policyholders. In addition to the potential effect of natural or man-made disasters, significant
changes in mortality or morbidity could emerge gradually over time, due to changes in the natural environment,
the health habits of the insured population, treatment patterns for disease or disability, the economic
environment, or other factors. Pricing of PICA‘s insurance and deferred annuity products is also based in part
upon expected persistency of these products, which is the probability that a policy or contract will remain in
force from one period to the next. Persistency within its Individual Annuities business may be significantly
impacted by the value of guaranteed minimum benefits contained in many of its variable annuity products being
higher than current account values in light of equity market declines. Results may also vary based on
differences between actual and expected premium deposits and withdrawals for these products. The
development of a secondary market for life insurance, including life settlements or ―viaticals‖ and investor
owned life insurance, could adversely affect the profitability of existing business and pricing assumptions for
new business. Significant deviations in actual experience from PICA pricing assumptions could have an adverse
effect on the profitability of its products. Although some of PICA‘s products permit it to increase premiums or
adjust other charges and credits during the life of the policy or contract, the adjustments permitted under the
terms of the policies or contracts may not be sufficient to maintain profitability. Many of PICA‘s products do
not permit it to increase premiums or adjust other charges and credits or limit those adjustments during the life
of the policy or contract.
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PICA may be required to recognize impairment in the value of goodwill it has recorded which could adversely
affect its results of operations or financial conditions.
Goodwill represents the excess of the amounts PICA paid to acquire subsidiaries over the fair value of
the net assets at the acquisition date. As of March 31, 2009 PICA had $361 million of goodwill related to its
investment in PRIAC, all of which was admitted. Goodwill is subject to regular amortization as well as
assessment for potential impairment. Goodwill is assessed for impairment by comparing the carrying value of
the investment to which it relates, inclusive of goodwill, to the fair value of the investment. To the extent the
fair value is below the current carrying value of the investment, and this condition is deemed to be other-than-
temporary, goodwill would be impaired for the difference. Further market declines or other events impacting
the fair value of PICA‘s investment in PRIAC may result in an impairment of goodwill, resulting in a charge to
income.
PICA’s valuation of fixed maturity and equity securities may include methodologies, estimations and
assumptions that are subject to differing interpretations and could result in changes to investment valuations
that may materially adversely affect its results of operations or financial condition.
During periods of market disruption, such as the unprecedented current market conditions, it may be
difficult to value certain of PICA‘s securities, such as sub-prime mortgage backed securities, if trading becomes
less frequent and/or market data becomes less observable. There may be certain asset classes that were in active
markets with significant observable data that become illiquid due to the current financial environment or market
conditions. As a result, valuations may include inputs and assumptions that are less observable or require greater
estimation and judgment as well as valuation methods which are more complex. These values may not be
ultimately realizable in a market transaction, and such values may change very rapidly as market conditions
change and valuation assumptions are modified. Decreases in value may have a material adverse effect on its
results of operations or financial condition.
The decision on whether to record an other-than-temporary impairment or write-down is determined in
part by management‘s assessment of the financial condition and prospects of a particular issuer, projections of
future cash flows and recoverability of the particular security as well as an evaluation of PICA‘s intent to sell its
investment before recovery.
PICA has experienced and may experience additional downgrades in its claims paying or credit ratings. A
downgrade or potential downgrade in PICA’s claims-paying or credit ratings could limit its ability to market
products, increase the number or value of policies being surrendered, increase its borrowing costs and/or
hurt its relationships with creditors or trading counterparties and restrict its access to alternative sources of
liquidity.
Unfavorable results of PICA‘s businesses may adversely affect its ratings. Claims-paying ratings, which are
sometimes referred to as ―financial strength‖ ratings, represent the opinions of rating agencies regarding the
financial ability of an insurance company to meet its obligations under an insurance policy, and are important
factors affecting public confidence in an insurer, including PICA, and its competitive position in marketing
products. A downgrade in PICA‘s claims-paying rating could potentially, among other things, limit its ability to
market products, reduce its competitiveness and profitability, increase the number or value of policy surrenders
and withdrawals, increase its borrowing costs and potentially make it more difficult to borrow funds, adversely
affect the availability of financial guarantees, such as letters of credit, cause additional collateral requirements
under certain agreements, allow counterparties to terminate derivative agreements, and/or hurt its relationships
with creditors or trading counterparties. In addition, actions PICA might take to access third party financing or
to realign its capital structure may in turn cause rating agencies to reevaluate its ratings.
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In view of the difficulties experienced recently by many financial institutions, the rating agencies have
heightened the level of scrutiny that they apply to such institutions, have increased the frequency and scope of
their credit reviews, have requested additional information from the companies that they rate, and may adjust
upward the capital and other requirements employed in the rating agency models for maintenance of certain
ratings levels, such as PICA‘s financial strength ratings. The outcome of such reviews may have adverse ratings
consequences, which could have a material adverse effect on PICA‘s results of operation and financial
condition, as well as a corresponding effect on the rating of the Notes.
In late September and early October, 2008, A.M. Best Company, Inc. (―A.M. Best‖), Fitch Ratings Ltd.
(―Fitch‖), Moody‘s Investors Service, Inc. (―Moody‘s‖), and Standard & Poor‘s Rating Services, a division of
The McGraw-Hill Companies, Inc. (―S&P‖), respectively, each revised its outlook for the U.S. life insurance
sector to negative from stable, citing, among other things, the significant deterioration and volatility in the credit
and equity markets, economic and political uncertainty, and the expected impact of realized and unrealized
investment losses on life insurers‘ capital levels and profitability.
On November 21, 2008, Moody‘s affirmed the financial strength rating of PICA at ―Aa3.‖ Moody‘s also
revised its outlook on PICA‘s ratings to negative from stable. On February 10, 2009, Moody‘s placed the long-
term ratings of PICA on review for possible downgrade. On March 18, 2009, Moody‘s lowered the financial
strength rating of PICA to ―A2‖ from ―Aa3.‖ The outlook for this rating is negative. Moody‘s also placed the
short-term rating of Prudential Funding, LLC on review for possible downgrade.
On December 2, 2008, Fitch lowered the financial strength rating of PICA to ―AA-‖ from ―AA,‖ with the
ratings outlook revised from stable to negative. On February 19, 2009, Fitch downgraded the financial strength
rating of PICA to ―A+‖ from ―AA-.‖ The outlook for the rating remains negative.
On December 11, 2008, A.M. Best affirmed the financial strength rating of ―A+‖ for PICA. The outlook for
the financial strength rating remained stable. However, on May 27, 2009, A.M. Best Co. affirmed PICA‘s
financial strength rating at ―A+‖ and revised the outlook on that rating to negative from stable.
On February 17, 2009, S&P affirmed its ―AA‖ financial strength rating for PICA. The long-term ratings
outlook was revised from stable to negative. On February 26, 2009, S&P lowered the financial strength rating
for PICA to ―AA-‖ from ―AA.‖ The outlook was revised from negative to stable.
Both PFI‘s and PF‘s commercial paper programs were granted approval to participate in the Federal
Reserve‘s Commercial Paper Funding Facility (―CPFF‖), during the fourth quarter of 2008. Commercial paper
issuers must maintain ratings of at least A-1/P-1/F1 by two rating agencies in order to be eligible for CPFF. On
February 19, 2009, PFI‘s commercial paper rating was downgraded by Fitch from F1 to F2 and, consequently,
as of that date, PFI was no longer eligible to issue commercial paper under the CPFF. As of March 31, 2009,
PFI had $374 million of commercial paper outstanding under the CPFF. As of the date of this filing, PF‘s
commercial paper is rated A-1+/P-1/F1; however, as noted above, on March 18, 2009, Moody‘s placed PF‘s
commercial paper rating on review for possible downgrade and the Fitch rating has a negative outlook. If PF
fails to maintain the required A-1/P-1/F1 ratings by at least two rating agencies, its program would no longer be
eligible for CPFF, and PICA and its affiliates would lose access to CPFF completely. As of March 31, 2009, PF
had $750 million of commercial paper outstanding under the CPFF.
PICA cannot predict what additional actions rating agencies may take, or what actions PICA may
take in response to the actions of rating agencies, which could adversely affect its business. As with other
companies in the financial services industry, its ratings could be downgraded at any time and without
notice by any rating agency.
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Ratings downgrades and changes in credit spreads may require PICA to post collateral, thereby affecting
its liquidity, and PICA may be unable to effectively implement certain capital management activities as a
result, or for other reasons.
A downgrade in PICA‘s credit or financial strength ratings could result in additional collateral
requirements or other required payments under certain agreements, including derivative agreements, which are
eligible to be satisfied in cash or by posting securities, thereby affecting PICA‘s liquidity.
A ratings downgrade of three ratings levels from the ratings levels at March 31, 2009 would result in
estimated collateral posting requirements or payments under such agreements of approximately $200 million. In
addition, a ratings downgrade by A.M. Best to ―A-― would require PICA to post a letter of credit in the amount
of approximately $1.5 billion based on the level of statutory reserves related to an acquired business that it
estimates would result in annual cash outflows of approximately $180 million, or collateral posting in the form
of cash or securities to be held in a trust.
In addition, agreements in connection with capital management activities for its universal life insurance
products would require PICA to post cash collateral based on tests that consider the level of 10-year credit
default swap spreads on PFI‘s senior debt. As of March 31, 2009, when estimates of PFI‘s 10-year credit default
swap spreads were 860 basis points, PICA posted $145 million of collateral under this agreement. PICA
estimates that the collateral posting requirements could be up to $400 million at an effective 10-year credit
default swap spread of 2,000 basis points, based on indications of forward LIBOR rates as of March 31, 2009.
The National Association of Insurance Commissioners (the ―NAIC‖) has adopted a Model Regulation
entitled ―Valuation of Life Insurance Policies,‖ commonly known as ―Regulation XXX,‖ and a supporting
Guideline entitled ―The Application of the Valuation of Life Insurance Policies,‖ commonly known as
―Guideline AXXX.‖ The Regulation and supporting Guideline require insurers to establish statutory reserves for
term and universal life insurance policies with long-term premium guarantees that are consistent with the
statutory reserves required for other individual life insurance policies with similar guarantees. Many market
participants believe that this level of reserves is excessive, and PICA has implemented reinsurance and capital
management actions to mitigate the impact of Regulation XXX and Guideline AXXX on its term and universal
life insurance business. However, PICA may not be able to implement actions to mitigate the impact of
Regulation XXX or Guideline AXXX on its term or universal life insurance products, thereby potentially
resulting in an adverse impact on returns on capital associated with these products, and possibly requiring PICA
to reduce its sales of these products or implement measures that may be disruptive to its business. As PICA
continues to underwrite term and universal life business, PICA expects to have borrowing needs in 2009 to
finance statutory reserves required under Regulation XXX and Guideline AXXX. Several strategies are
currently under review to reduce the strain of increased AXXX and XXX statutory reserves associated with
PICA‘s term and universal life products. The activities PICA may undertake to mitigate or address these needs
include obtaining letters of credit, entering into reinsurance transactions or executing other capital market
strategies; however, its ability to successfully execute these strategies may depend on market conditions.
Further, PICA has $300 million currently available under a XXX notes facility. Absent any successful
mitigation efforts and assuming full usage of the XXX notes facility, PICA currently believes that its financing
need for 2009 could be up to $200 million for XXX and AXXX combined, but this amount may fluctuate due to
changes in market conditions or product sales. If it is unsuccessful in satisfying or mitigating this strain as a
result of market conditions or otherwise, this financing need could have an adverse effect on PICA‘s overall
liquidity and capital and could require it to increase prices and/or reduce sales of term or universal life products.
Losses due to defaults by others, including issuers of investment securities or reinsurance, bond insurers and
derivative instrument counterparties, downgrades in the rating of securities PICA holds or ratings of bond
insurers, and insolvencies of insurers in jurisdictions where PICA writes business, could adversely affect the
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value of PICA’s investments, the realization of amounts currently owed to it, result in assessments or
additional statutory capital requirements or reduce its profitability.
Issuers and borrowers whose securities or loans PICA holds, customers, vendors, trading counterparties,
counterparties under swaps and other derivative contracts, reinsurers, clearing agents, exchanges, clearing
houses and other financial intermediaries and guarantors, including bond insurers, may default on their
obligations to PICA or be unable to perform service functions that are significant to its business due to
bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud or other
reasons. Such defaults, instances of which have occurred in recent months, could have an adverse effect on
PICA‘s results of operations and financial condition. A downgrade in the ratings of bond insurers could also
result in declines in the value of PICA‘s fixed maturity investments supported by guarantees from bond insurers.
In addition, PICA uses derivative instruments to hedge various risks, including certain guaranteed
minimum benefits contained in many of its variable annuity products. PICA enters into a variety of derivative
instruments, including options, forwards, interest rate, credit default and currency swaps with a number of
counterparties. PICA‘s obligations under its variable annuity products are not changed by its hedging activities
and PICA is liable for its obligations even if its derivative counterparties do not pay PICA. This is a more
pronounced risk to PICA in view of the recent stresses suffered by financial institutions. Such defaults could
have a material adverse effect on PICA‘s financial condition and results of operations.
Under state insurance guaranty association laws and similar laws in international jurisdictions, PICA is
subject to assessments, based on the share of business PICA writes in the relevant jurisdiction, for certain
obligations of insolvent insurance companies to policyholders and claimants. Amounts that PICA expects to
collect under current and future contracts, including proceeds PICA expects to realize from the intended put of
the Wachovia Securities joint venture interests to Wells Fargo, are subject to counterparty risk.
Intense competition could adversely affect PICA’s ability to maintain or increase its market share or
profitability.
In each of its businesses, PICA faces intense competition from domestic and foreign insurance companies,
asset managers and diversified financial institutions, both for the ultimate customers for its products and, in
many businesses, for distribution through non-affiliated distribution channels. PICA competes based on a
number of factors including brand recognition, reputation, quality of service, quality of investment advice,
investment performance of PICA‘s products, product features, scope of distribution and distribution
arrangements, price, perceived financial strength and claims-paying and credit ratings. A decline in PICA‘s
competitive position as to one or more of these factors could adversely affect its profitability and assets under
management. Many of PICA‘s competitors are large and well established and some have greater market share or
breadth of distribution, offer a broader range of products, services or features, assume a greater level of risk,
have lower profitability expectations or have higher claims-paying or credit ratings than PICA does. PICA
could be subject to claims by competitors that its products infringe their patents, which could adversely affect its
sales, profitability and financial position. The proliferation and growth of non-affiliated distribution channels
puts pressure on PICA‘s captive sales channels to increase their productivity and reduce their costs in order to
remain competitive, and PICA runs the risk that the marketplace will make a more significant or rapid shift to
non-affiliated or direct distribution alternatives than PICA anticipates or is able to achieve itself, potentially
adversely affecting its market share and results of operations. Competition for personnel in all of PICA‘s
businesses is intense. The loss of personnel could have an adverse effect on PICA‘s business and profitability.
The adverse market and economic conditions that began in the second half of 2007 and that have continued
and worsened since then can be expected to result in changes in the competitive landscape. For example, the
financial distress experienced by certain financial services industry participants as a result of such conditions
may lead to favorable acquisition opportunities, although PICA‘s ability or that of its competitors to pursue such
opportunities may be limited due to lower earnings, reserve increases, and a lack of access to debt capital
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markets and other sources of financing. Such conditions may also lead to changes by PICA or its competitors in
product offerings, product pricing and business mix that could affect its and their relative sales volumes, market
shares and profitability. Additionally, the competitive landscape in which PICA operates may be further
affected by the government sponsored programs in the U.S. and similar governmental actions outside of the U.S.
in response to the severe dislocations in financial markets.
Changes in U.S. federal income tax law or in the income tax laws of other jurisdictions in which PICA
operates could make some of its products less attractive to consumers and increase its tax costs.
Current U.S. federal income tax laws generally permit certain holders to defer taxation on the build-up of
value of annuities and life insurance products until payments are actually made to the policyholder or other
beneficiary and to exclude from taxation the death benefit paid under a life insurance contract. Congress from
time to time considers legislation that could make PICA‘s products less attractive to consumers, including
legislation that would reduce or eliminate the benefit of this deferral on some annuities and insurance products,
as well as other types of changes that could reduce or eliminate the attractiveness of annuities and life insurance
products to consumers, such as repeal of the estate tax.
For example, the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth
Tax Relief Reconciliation Act of 2003 generally provided for lower income tax, capital gains and dividend tax
rates that had the effect of reducing the benefits of tax deferral on the build-up of value of annuities and life
insurance products. Continuation of these reduced rates, which are due to sunset in 2011, may hinder PICA‘s
sales and result in the increased surrender of insurance and annuity products.
Congress, as well as state and local governments, also considers from time to time legislation that could
increase the amount of corporate taxes PICA pays. For example, changes in the law relating to tax reserving
methodologies for term life or universal life insurance policies with secondary guarantees could result in higher
corporate taxes. If such legislation is adopted PICA‘s net income could decline.
On 11th May 2009, the Obama Administration released the ―General Explanations of the Administration‘s
Revenue Proposals.‖ Although the Administration has not released proposed statutory language, the ―General
Explanations of the Administration‘s Revenue Proposals‖ includes proposals which if enacted, would affect the
taxation of life insurance companies and certain life insurance products. In particular, the proposals would affect
the treatment of corporate owned life insurance policies or ―COLIs‖ by limiting the availability of certain
interest deductions for companies that purchase those policies. The proposals would also change the method
used to determine the amount of dividend income received by a life insurance company on assets held in
separate accounts used to support products, including variable life insurance and variable annuity contracts, that
is eligible for the dividends-received deduction, or ―DRD.‖ The DRD reduces the amount of dividend income
subject to tax and is a significant component of the difference between PICA‘s actual tax expense and expected
amount determined using the federal statutory tax rate of 35%. If proposals of this type were enacted, PICA‘s
sale of COLI, variable annuities, and variable life products could be adversely affected and PICA‘s actual tax
expense could increase, reducing earnings.
The products PICA sells have different tax characteristics, in some cases generating tax deductions. The
level of profitability of certain of its products are significantly dependent on these characteristics and PICA‘s
ability to continue to generate taxable income, which are taken into consideration when pricing products and are
a component of its capital management strategies. Accordingly, a change in tax law, or other factors impacting
the availability of the tax characteristics generated by PICA‘s products, could impact product pricing and returns or require it to reduce sales of these products or implement other actions that could be disruptive to its
business.
Fluctuations in foreign currency exchange rates could adversely affect PICA’s profitability.
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PICA is exposed to foreign currency exchange risks in its general account investment portfolios and other
proprietary investment portfolios and its hedging programs. As a result, currency fluctuations may adversely
affect PICA‘s results of operations or financial condition.
PICA’s businesses are heavily regulated and changes in regulation may reduce its profitability.
Insurance operations are subject to state insurance laws regulating all aspects of the business and are
regulated and supervised principally by state insurance departments in the fifty states, the District of Columbia
and the U.S. territories and possessions. The principal insurance regulatory authorities for PICA are the New
Jersey Department of Banking and Insurance and the state insurance authorities in other states where its
insurance subsidiaries are organized. The purpose of the state regulation of insurance is to protect policyholders
and not necessarily to protect other constituencies such as shareholders and creditors. Products that are also
"securities," such as variable life insurance and variable annuities, are also subject to federal securities laws and
are regulated and supervised by the SEC and the Financial Industry Regulatory Authority ("FINRA") (formerly
the National Association of Securities Dealers, Inc). In certain states, these products are also regulated by state
securities commissions. See "Business of PICA – Regulation." Many of the laws and regulations to which
PICA is subject are regularly re-examined, and existing or future laws and regulations may become more
restrictive or otherwise adversely affect PICA‘s business, results of operations or financial conditions. This is
particularly the case under current market conditions. It appears likely that the continuing financial markets
dislocation will lead to extensive changes in existing laws and regulations, and regulatory frameworks,
applicable to PICA.
State insurance guaranty associations have the right to assess insurance companies doing business in their
state for funds to help pay the obligations of insolvent insurance companies to policyholders and claimants.
Because the amount and timing of an assessment is beyond the control of PICA, the reserves that it has currently
established for these potential liabilities may not be adequate.
Many insurance regulatory and other governmental or self-regulatory bodies have the authority to review
PICA‘s products and business practices and those of its agents and employees and to bring regulatory or other
legal actions against PICA if, in their view, its practices, or those of its agents or employees, are improper.
These actions can result in substantial fines, penalties or prohibitions or restrictions on PICA‘s business
activities and could adversely affect its business, reputation, results of operations or financial condition. For a
discussion of material pending litigation and regulatory matters, see ―Business of PICA - Litigation and
Regulatory Matters.‖ Congress from time to time considers pension reform legislation that could decrease the
attractiveness of certain of PICA‘s retirement products and services to retirement plan sponsors and
administrators, or have an unfavorable effect on its ability to earn revenues from these products and services. In
this regard, the Pension Protection Act of 2006 (―PPA‖) makes significant changes in employer pension funding
obligations associated with defined benefit pension plans which are likely to increase sponsors‘ costs of
maintaining these plans. These changes could hinder PICA‘s sales of defined benefit pension products and
services and cause sponsors to discontinue existing plans for which PICA provides asset management,
administrative, or other services, but could increase the attractiveness of certain group annuity products PICA
offers in connection with terminating pension plans. Certain tax-favored savings initiatives that have been
proposed could hinder sales and persistency of PICA‘s products and services that support employment based
retirement plans.
Insurance regulators, as well as industry participants, have also begun to consider potentially significant
changes in the way in which statutory reserves and statutory capital are determined, particularly for products
with embedded options and guarantees. New regulatory capital requirements have already gone into effect for
variable annuity products. The timing of, and extent of, such changes to the statutory reporting framework are
uncertain; however, the result could be increases to statutory reserves and capital, and an adverse effect on
PICA‘s products, sales and operating costs. Moreover, insurance regulators recently deferred mandatory
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adoption of changes to the statutory accounting rules for loan-backed and structured securities. Further changes
to these rules by insurance regulators, or the timing of PICA‘s application of these rules, are possible, given the
deferral and other uncertainty around the resolution of these accounting rules.
In view of recent events involving certain financial institutions, it is likely that the U.S. federal government
will heighten its oversight of companies in the financial services industry such as PFI, including possibly
through a federal system of insurance regulation or broad regulations intended to address systemic risks to the
financial system. PICA cannot predict whether this or other proposals will be adopted, or what impact, if any,
such proposals or, if enacted, such laws, could have on PICA‘s business, financial condition or results of
operations.
Compliance with applicable laws and regulations is time consuming and personnel-intensive, and changes
in these laws and regulations may materially increase PICA‘s direct and indirect compliance and other expenses
of doing business, thus having a material adverse effect on PICA‘s financial condition and results of operations.
Legal and regulatory actions are inherent in PICA’s businesses and could adversely affect its results of
operations or financial position or harm its businesses or reputation.
PICA is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its
businesses, including in businesses that PICA has divested or placed in wind-down status. Some of these
proceedings have been brought on behalf of various alleged classes of complainants. In certain of these matters,
the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages.
Substantial legal liability in these or future legal or regulatory actions could have an adverse affect on PICA or
cause it reputational harm, which in turn could harm its business prospects.
Material pending litigation and regulatory matters affecting PICA, and certain risks to PICA‘s businesses
presented by such matters, are discussed under ―Business of PICA – Litigation and Regulatory Matters.‖
PICA‘s litigation and regulatory matters are subject to many uncertainties, and given their complexity and
scope, their outcome cannot be predicted. As a result, PICA‘s reserves for litigation and regulatory matters may
prove to be inadequate. It is possible that PICA‘s results of operations or cash flow in a particular quarterly or
annual period could be materially affected by an ultimate unfavorable resolution of pending litigation and
regulatory matters depending, in part, upon the results of operations or cash flow for such period. In light of the
unpredictability of PICA‘s litigation and regulatory matters, it is also possible that in certain cases an ultimate
unfavorable resolution of one or more pending litigation or regulatory matters could have a material adverse
effect on PICA‘s financial position.
The occurrence of natural or man-made disasters could adversely affect PICA’s results of operations and
financial condition.
The occurrence of natural disasters, including hurricanes, floods, earthquakes, tornadoes, fires, explosions,
pandemic disease and man-made disasters, including acts of terrorism and military actions, could adversely
affect PICA‘s results of operations or financial condition, including in the following respects:
Catastrophic loss of life due to natural or man-made disasters could cause PICA to pay benefits at
higher levels and/or materially earlier than anticipated and could lead to unexpected changes in
persistency rates.
A natural or man-made disaster could result in losses in PICA‘s investment portfolio or the failure of
PICA‘s counterparties to perform, or cause significant volatility in global financial markets.
A terrorist attack affecting financial institutions in the United States or elsewhere could negatively
impact the financial services industry in general and PICA‘s business operations, investment portfolio
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and profitability in particular. As previously reported, in August 2004, the U.S. Department of
Homeland Security identified PICA‘s Newark, New Jersey facilities, along with those of several other
financial institutions in New York and Washington, D.C., as possible targets of a terrorist attack.
Pandemic disease, caused by a virus, such as H5N1, the ―avian flu‖ virus, or H1N1, the ―swine flu‖
virus could have a severe adverse effect on PICA‘s business. The potential impact of such a pandemic
on PICA‘s results of operations and financial position is highly speculative, and would depend on
numerous factors, including: in the case of the avian flu virus, the probability of the virus mutating to a
form that can be passed from human to human; the rate of contagion if and when that occurs; the
regions of the world most affected; the effectiveness of treatment for the infected population; the rates
of mortality and morbidity among various segments of the insured versus the uninsured population; the
collectibility of reinsurance; the possible macroeconomic effects of a pandemic on PICA‘s asset
portfolio; the effect on lapses and surrenders of existing policies, as well as sales of new policies; and
many other variables.
There can be no assurance that PICA‘s business continuation plans and insurance coverages would be
effective in mitigating any negative effects on its operations or profitability in the event of a terrorist
attack or other disaster.
PICA’s risk management policies and procedures and its minority investments in joint ventures may leave it
exposed to unidentified or unanticipated risk, which could adversely affect its businesses or result in losses.
PICA‘s policies and procedures to monitor and manage risks, including hedging programs that utilize
derivative financial instruments, may not be fully effective and may leave PICA exposed to unidentified and
unanticipated risks. PICA uses models in its hedging programs and many other aspects of its operations,
including but not limited to the estimation of actuarial reserves, the amortization of deferred acquisition costs
and the value of business acquired, and the valuation of certain other assets and liabilities. These models rely on
assumptions and projections that are inherently uncertain. Management of operational, legal and regulatory
risks requires, among other things, policies and procedures to record properly and verify a large number of
transactions and events, and these policies and procedures may not be fully effective. Past or future misconduct
by its employees or employees of its vendors could result in violations of law by PICA, regulatory sanctions
and/or serious reputational or financial harm and the precautions PICA takes to prevent and detect this activity
may not be effective in all cases. A failure of PICA‘s computer systems or a compromise of their security could
also subject PICA to regulatory sanctions or other claims, harm its reputation, interrupt its operations and
adversely affect its business, results of operations or financial condition.
With respect to PICA‘s investments in which it holds a minority interest, including Wachovia Securities
Financial Holdings, LLC, PICA lacks management and operational control over the operations of those
investments, which may prevent it from taking or causing to be taken actions to protect or increase the value of
those investments.
PICA faces risks arising from acquisitions, divestitures and restructurings, including client losses,
surrenders and withdrawals, difficulties in integrating and realizing the projected results of acquisitions and
contingent liabilities with respect to dispositions.
PICA faces a number of risks arising from acquisition transactions, including the risk that, following the
acquisition or reorganization of a business, PICA could experience client losses, surrenders or withdrawals or
other results materially different from those PICA anticipates, as well as difficulties in integrating and realizing
the projected results of acquisitions and restructurings and managing the litigation and regulatory matters to
which acquired entities are party. PICA has retained insurance or reinsurance obligations and other contingent
liabilities in connection with its divestiture or winding down of various businesses and its reserves for these
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obligations and liabilities may prove to be inadequate. These risks may adversely affect PICA‘s results of
operations or financial condition.
Changes in PICA’s discount rate, expected rate of return and expected compensation increase assumptions
for PICA's pension and other postretirement benefit plans may result in increased expenses and reduce
PICA’s profitability.
PICA determines its pension and other postretirement benefit plan costs based on assumed discount rates,
expected rates of return on plan assets and expected increases in compensation levels and trends in health care
costs. Changes in these assumptions may result in increased expenses and reduce PICA‘s profitability.
Poor investment performance of the Closed Block assets and related assets could have an adverse effect on
holders of the Notes.
PICA operates the Closed Block to provide for the reasonable dividend expectations of policyholders who
own participating individual life insurance policies and annuities included in the Closed Block. PICA expects
the initial Closed Block assets, together with revenues generated by such assets and by the Closed Block
policies, to be reasonably sufficient to support the obligations and liabilities relating to these policies.
However, there are numerous factors that may adversely affect the experience of the Closed Block and the
cash flows generated by the Closed Block, including mortality, lapse rates, interest rates and the investment
environment. There can be no assurance that the Closed Block assets and revenues generated by such assets and
the Closed Block policies will continue to be sufficient to provide for benefits payable under the Closed Block
policies, dividends declared with respect to the Closed Block policies and other Closed Block liabilities.
Neither the terms of the Closed Block nor the separation of the Closed Block business from the other
businesses of PICA affects the rights of policyholders (both Closed Block policyholders and non-Closed Block
policyholders) and other creditors of PICA to have their claims satisfied out of PICA‘s total assets in the event
of PICA‘s insolvency.
In general, the Closed Block assets and related assets will not be available to satisfy obligations under the
Funding Agreements.
Under the Plan of Reorganization (as defined below), and in the absence of a PICA insolvency, PICA
cannot use the Closed Block assets for any purpose other than the payment of benefits on Closed Block policies
(including policy dividends), administrative expenses and taxes as allowed in the Plan of Reorganization
without the prior approval of the New Jersey Commissioner of Banking and Insurance. In addition, transfer of
Closed Block assets and related assets is limited by certain policies that have been approved by the board of
directors of PFI and certain restrictive covenants.
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ANNEX A
Definitions
Asset Liability Management – A unit within PFI that develops and implements investment policies, long-term
investment plans and tactical investment strategies for PICA's general account asset portfolios. The unit is
responsible for asset allocation, asset liability matching and designing investment policies and strategies that are
consistent with products sold and developed by PICA's Retirement, Annuity, Individual Insurance and Group
Insurance profit centers.
AVR – Asset Valuation Reserve, established under SAP as a liability to offset potential non-interest related
investment losses. Changes in AVR are charged or credited directly to surplus; no such reserve is required
under GAAP.
Closed Block – PICA‘s liabilities for certain participating individual life insurance policies and annuities issued
in the United States were segregated, together with assets which will be used exclusively for the payment of
benefits, policyholder dividends and taxes with respect to these products, in a regulatory mechanism referred to
as the ―Closed Block.‖
Commissioner – State Insurance Department Commissioners
FHLBNY – Federal Home Loan Bank of New York
GAAP – Generally Accepted Accounting Principles, in the United States of America.
Gibraltar – The Gibraltar Life Insurance Company, Ltd., an affiliate of PICA.
GICs – Guaranteed Investment Contracts.
IMR – Interest Maintenance Reserve, established under SAP, to capture realized investment gains and losses,
net of tax, on the sale of bonds resulting from changes in the general level of interest rates, and is amortized into
income over the remaining years to expected maturity of the assets sold; no such reserve is required under
GAAP.
Investment Manager – Prudential Investment Management, Inc.
IRS – Internal Revenue Service
Moody’s – Moody‘s Investors Service, Inc.
NAIC – National Association of Insurance Commissioners.
PFI – Prudential Financial, Inc., a New Jersey stock corporation and the ultimate parent company of PICA, PH
and all of their respective subsidiaries or affiliates.
PF – Prudential Funding, LLC, a New Jersey limited liability company and a wholly owned financing
subsidiary of PICA.
PH – Prudential Holdings, LLC, a New Jersey limited liability company that owns all of the issued and
outstanding shares of the capital stock of PICA.
PICA – The Prudential Insurance Company of America, a New Jersey stock life insurance company.
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PLI – Pruco Life Insurance Company.
PLIC – The Prudential Life Insurance Company Ltd., an affiliate of PICA.
PLICK – The Prudential Life Insurance Company of Korea, Ltd., an affiliate of PICA.
PLICT – The Prudential Life Insurance Company of Taiwan, an affiliate of PICA.
PRIAC – The Prudential Retirement Insurance and Annuity Company, a wholly owned subsidiary of PICA.
SAP – Statutory Accounting Principles.
SVO – The Securities Valuation Office, a division of the NAIC.
S&P – Standard and Poor‘s Ratings Services, a division of The McGraw-Hill Companies, Inc.
TOLI – Trust owned life insurance
UPARC – Universal Prudential Arizona Reinsurance Company