The Company's profitability depends principally on its ability and Prudential Financial's ability to price and manage risk on insurance products, to attract and retain customer assets, and to manage expenses. Specific drivers of our profitability include:
The preparation of financial statements in conformity with U.S. GAAP requires the application of accounting policies that often involve a significant degree of judgment. Management, on an ongoing basis, reviews estimates and assumptions used in the preparation of financial statements. If management determines that modifications in assumptions and estimates are appropriate given current facts and circumstances, results of operations and financial position as reported in the Consolidated Financial Statements may change significantly.
Valuation of investments For fixed maturities classified as available for sale, the impact of changes in fair value is recorded in "Accumulated other comprehensive (loss) income," a separate component of equity. However, the carrying value of these securities is reduced, with a corresponding charge to earnings, when a decline in value is considered to be other than temporary. Factors we consider in determining whether a decline in value is other than temporary include: whether the decline is substantial; the length of time the fair value has been less than cost, generally six months; the financial strength rating of the issuer; the Company's ability and intent to hold the investment; and the financial condition and near-term prospects of the issuer. This corresponding charge is referred to as an impairment and is reflected in "Realized investment (losses) gains, net" in the Consolidated Statements of Operations and Comprehensive Income. The level of impairment losses can be expected to increase when economic conditions worsen and decrease when economic conditions improve.
Future fees payable to ASI In a series of transactions with ASI, the Company sold certain rights to receive a portion of future fees and contract charges expected to be realized on designated blocks of deferred annuity contracts.
Management believes that based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. Adjustments to the valuation allowance will be made if there is a change in management's assessment of the amount of the deferred tax asset that is realizable.
During the year, liabilities increased by $3.6 billion from $23.0 billion to $26.7 billion. Corresponding with the asset change, Separate account liabilities increased by $3.9 billion, as described above. Income taxes payable, which is a net number comprised of payables and receivables, increased by $28.0 million primarily as a result of the Acquisition. Other liabilities increased by $68.3 million primarily due to the establishment of liabilities through purchase accounting for vacant office space, severance and an indemnification agreement. Short-term borrowing increased by $106.0 million in order to fund the cash strain generated from acquisition costs. Future fees payable to ASI decreased by $400.4 million primarily due to purchase accounting. Surplus notes decreased due to the conversion of the notes to paid in capital as part of the Acquisition.
Net Income Net income of $98.7 million for 2003 was an improvement of $264.0 million from the loss of $165.3 million for 2002. 2002 had an additional charge for DAC amortization of approximately $278.0 million, which did not recur in 2003. Further details regarding the components of revenues and expenses are described in the following paragraphs.
Revenues Revenues decreased by $23.4 million, from $507.5 million to $484.1 million. Realized investment gains decreased by $27.3 million mainly due to lower derivative income of $41.2 million. The prior year included economic hedge related gains from the Company's derivative investments of $31.8 million compared to losses of $9.4 million in the current year. The Company has had no outstanding derivative positions since May 2003.
Net investment income increased by $7.0 million primarily as a result of a $13.9 million increase in net investment results on the Company's separate account supporting its fixed, market value adjusted investment option due to an increase in average separate account balances. Favorable net investment results were partially offset by decreased income from fixed maturities of $5.1 million.
Asset management fees decreased by $3.5 million as a result of lower average assets under management compared to last year. Asset management fees are asset-based fees, which are dependent on the amount of assets under management.
Benefits and Expenses Policyholders' benefits increased by $7.2 million primarily from increased GMDB payments. GMDB payments increased by $3.6 million from $55.1 million in 2002 to $58.7 million for 2003.
In addition to establishing a liability associated with the GMDB feature, SOP 03-01 requires a change in valuation and presentation of our liability associated with the market value adjustment ("MVA") feature contained in certain annuity contracts. The MVA feature requires the Company to pay to the contract holder upon surrender the accreted value of the fund as well as a market value adjustment based on the crediting rates on the contract surrendered compared to crediting rates on newly issued contracts. Currently, this liability is reflected at market value, which considers the effects of unrealized gains and losses in contract value resulting from changes in crediting rates. Upon adoption of SOP 03-01, the Company will reclassify this liability from "Separate account liabilities" to "Policyholders' account balances" and reduce it to reflect accreted value, which excludes the effect of unrealized gains and losses in contract value resulting from changes in crediting rates. However, in valuing the VOBA established at the date of acquisition, we considered the effect of unrealized gains and losses in contract value associated with annuities containing the MVA feature on future cash flows. As a result, the reduction in the liability for the MVA feature will result in a net decrease in VOBA of approximately $130.0 million, and lower future amortization. We currently estimate the net income statement impact of the reduction in liability associated with the MVA feature to be approximately $20.0 million, which primarily represents the impact of changes in crediting rates from May 1, 2003, the date of the Acquisition, through January 1, 2004, the date of the adoption of SOP 03-01.
General, administrative, and other expenses decreased by $373.6 million from the prior year. The primary reason was a decrease in DAC amortization of $382.5 million as the prior year had an additional charge for DAC amortization of approximately $278.0 million. Also contributing to decreased DAC amortization was the Company's DAC asset being assigned a fair value of zero, consistent with purchase accounting guidance as of the date of acquisition. Partially offsetting this was an increase in net VOBA amortization of $38.0 million related to purchase accounting.
The rate of inflation has not had a significant effect on the Company's financial statements.
Tax Legislation Current 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 the build-up of value, which is paid as a death benefit under a life insurance contract. Congress from time to time considers legislation that could make our products less attractive to consumers, including legislation that would reduce or eliminate the benefit of this deferral on some annuities and insurance products, as well as other types of changes that could reduce or eliminate the attractiveness of annuities and life insurance products to consumers.
In June 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "2001 Act") was enacted. The 2001 Act contains provisions that will, over time, significantly lower individual tax rates. This will have the effect of reducing the benefits of tax deferral on the build-up of value of annuities and life insurance products. The 2001 Act also includes provisions that will eliminate, over time, the estate, gift and generation-skipping taxes and partially eliminates the step-up in basis rule applicable to property held in a decedent's estate. Some of these changes might hinder our sales and result in the increased surrender of insurance and annuity products.
In May 2003, the Jobs and Growth Tax Relief Reconcilation Act of 2003 (the "2003 Act") was enacted Individual taxpayers are the principal beneficiaries of the 2003 Act, which includes an acceleration of certain of the income tax rate reductions enacted originally under the 2001 Act, as well as capital gains and dividend tax rate reductions. Although most of these rate reductions expire after 2008 or later, these reductions have the effect of reducing the benefits of tax deferral on the build-up of value of annuities and life insurance products. These changes may hinder our sales and result in increased surrender of insurance and annuity products.