The DAC balance associated with the variable and universal life policies as of December 31, 2009 was $1.0 billion. The following table provides a demonstration of the sensitivity of that DAC balance relative to our future mortality assumptions by quantifying the adjustments that would be required, assuming both an increase and decrease in our future mortality rate by 1%. While the information below is for illustrative purposes only and does not reflect our expectations regarding future mortality assumptions, it is a near-term, reasonably likely hypothetical change that illustrates the potential impact of such a change. This information considers only the direct effect of changes in our mortality assumptions on the DAC balance and not changes in any other assumptions such as persistency, future rate of return, or expenses included in our evaluation of DAC, and does not reflect changes in reserves, such as the unearned revenue reserve, which would partially offset the adjustments to the DAC balance reflected below.
We present our investments classified as available for sale, including fixed maturity and equity securities, our investments classified as trading, and derivatives, and our embedded derivatives at fair value in the statements of financial position. For additional information regarding the key estimates and assumptions surrounding the determination of fair value of fixed maturity and equity securities, as well as derivative instruments, embedded derivatives and other investments, see Note 10 to the Consolidated Financial Statements.
In establishing reserves for guaranteed minimum death and income benefits related to variable annuity policies, we must make estimates and assumptions about the timing of annuitization, contract lapses and contractholder mortality, as well as interest rates and equity market returns. Assumptions relating to contractholder behavior, such as the timing of annuitization and contract lapses, are based on our experience by contract group, and vary by product type and year of issuance. Our dynamic lapse rate assumption applies a different lapse rate on a contract by contract basis based on a comparison of the guaranteed minimum death or income benefit and the current policyholder account value as well as other factors such as the applicability of any surrender charges. In-the-money contracts are those with a guaranteed minimum benefit in excess of the current policyholder account value. Since in-the-money contracts are less likely to lapse, we apply a lower lapse rate assumption to these contracts. As an example, the lapse rate assumptions for contracts that are not in-the-money and out of their surrender charge period average between 8% and 20% per year. This lapse rate assumption would be reduced for similar in-the-money contracts, based on the extent of the excess described above and the age of the contract. Mortality assumptions are generally based on our historical experience or standard industry tables, and also vary by contract group. Unless a material change in behavior or mortality experience is observed in an interim period, we generally update assumptions related to contract holder behavior and mortality in the third quarter of each year by considering the actual results that have occurred during the period from the most recent update to the expected amounts. Generally, we do not expect our actual mortality trends to change significantly in the short-term, and to the extent these trends may change we expect such changes to be gradual over the long-term.
The Company’s liability for future policy benefits also includes net liabilities for guarantee benefits related to certain nontraditional long-duration life and annuity contracts, which are discussed more fully in Note 7, and certain unearned revenues.
Total assets increased $8.087 billion, from $30.996 billion at December 31, 2008 to $39.083 billion at December 31, 2009. Separate account assets increased $7.588 billion, from $17.575 billion at December 31, 2008 to $25.163 billion at December 31, 2009, primarily driven by positive net flows and improvements in equity markets.
Commercial loans increased $166 million, from $882 million at December 31, 2008, to $1.048 billion at December 31, 2009, during the current period due to continued investment in commercial loans.
Net realized investment losses, increased by $689 million from a gain of $282 million in 2008 to a loss of $407 million in 2009, primarily driven by a $710 million decrease attributable to changes in the value of the embedded derivative related to the no-lapse guarantee on our universal life products with UPARC. The value of the derivative decreased by $370 million in 2009 due to the impact of higher interest rates and the inclusion of non-performance risk in the valuation of the derivative, compared to a gain of $340 million in 2008 related to lower interest rates. Also contributing to the decrease was a $44 million mark-to-market decline on our other derivatives ($32 million loss in 2009 compared to a $12 million gain in 2008). Partially offsetting these losses were mark-to-market gains of $47 million ($16 million gain in 2009 compared to a $31 million loss in 2008) on certain externally managed European capital market investments and $20 million of lower impairments on fixed maturities ($16 million loss in 2009 compared to a $36 million loss in 2008).
Policy charges and fee income, consisting primarily of mortality and expense and other insurance charges assessed on general and separate account policyholders’ fund balances, decreased by $16 million from $438 million in 2008 to $422 million in 2009. The current year included lower amortization of unearned revenue reserves of $6 million and the prior year included lower amortization of unearned revenue reserves of $22 million due to updates to our assumptions related to the amortization of unearned revenue reserves based on the annual reviews as discussed below. Absent this item, policy charges and fee income decreased $32 million in 2009, primarily driven by a $49 million benefit in 2008 due to a correction of a reinsurance ceded premium error with an affiliate. Also contributing to the decline was lower amortization of unearned revenue reserves reflecting the impact of more favorable equity markets in 2009 on variable product separate account fund performance and higher amortization of unearned revenue reserves in 2008 due to the impact of unfavorable equity markets on separate account fund performance. The weak equity markets in the latter half of 2008 and first quarter of 2009 also drove lower average daily separate account assets ($7.7 billion in 2009 compared to a $8.8 billion in 2008) that resulted in lower asset management fees in 2009 compared to the prior year. The decrease in fees was, partially offset by continued growth in our universal life insurance in force resulting in higher policy charges as well as higher average policyholder fund balances and associated net investment income.
Net investment income increased $12 million from $228 million in 2008 to $240 million in 2009, primarily driven by growth in the portfolio due to growth in the universal life products and reinvestment of investment income.
Other income increased by $15 million from $28 million in 2008 to $43 million in 2009, primarily due to increased interest income on affiliated notes.
Net income increased $104 million from a loss of $73 million in 2008 to a gain of $31 million for 2009. This increase was driven by a $161 million increase in income from operations before income taxes, primarily driven by a decline in policyholders’ benefits, as discussed below, partially offset by a $57 million increase in tax expense due to the increase in pre-tax income.
Revenues increased $39 million from $331 million in 2008 to $370 million in 2009.
Losses from operations for 2009 for both our variable life and variable annuity products included $160 million of net benefits related to reductions to the reserves for the guaranteed minimum death and income benefit feature of our variable life and variable annuity contracts and lower DAC amortization driven by updates to our estimate of total gross profits used as a basis for amortizing deferred policy acquisition and other costs, compared to $180 million of net charges related to these items included in 2008, resulting in a $341 million favorable variance, as shown in the following table:
Amounts reflect (charges) or benefits for (increases) or decreases in unearned revenue reserves amortization that are reported in policy charges and fee income.
As shown in the table above, results for both periods include the impact of the annual reviews of the reserve for the guaranteed minimum death and income benefit features of both our variable life and variable annuity products and our estimate of total gross profits used as a basis for amortizing deferred policy acquisition and other costs. The third quarter of 2009 included $29 million of net charges from these annual reviews, primarily related to reductions in the future rate of return assumptions applied to the underlying assets associated with both our variable life and variable annuity products. The variable annuities future rate of return reduction was primarily driven by updates to the asset allocation assumptions for the underlying assets to reflect a higher percentage of lower-yielding fixed income investments. Partially offsetting the impact of the updated future rate of return assumptions were benefits from assumption updates to our variable and universal life products related to lower expected mortality and higher expected investment spreads. The third quarter of 2008 included $19 million of net benefit from these annual reviews, primarily reflecting mortality assumption updates.
The amounts in the table above primarily reflect the impact of market conditions that existed in the respective periods. Partially offsetting the net benefit from lower reserves and DAC amortization was $76 million of mark-to-market losses related to derivative positions associated with our capital hedging program. In the second quarter of 2009, we began a hedging program to mitigate a portion of the market exposure related to the overall capital position of our variable annuity products. These capital hedges are designed to partially offset changes in living and death benefit reserves on our variable annuity products resulting from equity market volatility.
Shown below is our income tax provision for the years ended December 31, 2009, 2008 and 2007, separately reflecting the impact of certain significant items. Also presented below is the income tax provision that would have resulted from application of the statutory 35% federal income tax rate in each of these periods.
Prudential Financial and the Company continue to operate with significant cash and short-term investments on the balance sheet and have access to alternate sources of liquidity. However, should the recent improvements in the capital markets prove temporary and the severity of prior markets return, such market disruptions could potentially adversely affect our ability to access sources of liquidity, as well as threaten to reduce our capital below a level that is consistent with our existing ratings objectives. Therefore, we may need to take certain actions, especially in the event of such disruptions, which may include but are not limited to: (1) further access our alternative sources of liquidity; (2) access external sources of capital; (3) limit or curtail sales of certain products and/or restructure existing products; (4) undertake asset sales; (5) seek temporary or permanent changes to regulatory rules; and (6) other capital management activities including reinsurance transactions. Certain of these activities may require regulatory approval and/or have economic costs associated with them.
We believe that the cash flows from our insurance and annuity operations are adequate to satisfy the current liquidity requirements of these operations, including under reasonably foreseeable stress scenarios. The continued adequacy of this liquidity will depend upon factors such as future
securities market conditions, changes in interest rate levels, policyholder perceptions of our financial strength, and the relative safety of competing products each of which could lead to reduced cash inflows or increased cash outflows. In addition, market volatility can impact the level of capital required to support our businesses, particularly in our annuity products. Our 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, commitments to invest and market volatility. We closely manage these risks through our credit risk management process and regular monitoring of our liquidity position. Further, the level of new business sales can also impact liquidity and additional financing, if necessary, may be required due to the potential increase in annuity sales as previous discussed.
Liquid assets include cash, cash equivalents, short-term investments, fixed maturities and public equity securities as of December 31, 2009 and December 31, 2008; our insurance operations had liquid assets of $6.198 billion and $5.232 billion, respectively. The portion of liquid assets comprised of cash and cash equivalents and short-term investments was $316.0 million and $671.2 million as of December 31, 2009 and December 31, 2008, respectively. As of December 31, 2009, $5.339 billion, or 91%, of the fixed maturity investments company general account portfolios were rated investment grade. The remaining $515 million, or 9%, of these fixed maturity investments were rated non-investment grade. We consider attributes of the various categories of liquid assets (for example, type of asset and credit quality) in calculating internal liquidity measures in order to evaluate the adequacy of our insurance operations’ liquidity under a variety of stress scenarios. We believe that the liquidity profile of our assets is sufficient to satisfy current liquidity requirements, including under foreseeable stress scenarios.
Our liquidity is managed through access to substantial investment portfolios as well as a variety of instruments available for funding and/or managing short-term cash flow mismatches, including from time to time those arising from claim levels in excess of projections. To the extent we need to pay claims in excess of projections, we may borrow temporarily or sell investments sooner than anticipated to pay these claims, which may result in increased borrowing costs or realized investment gains or losses affecting results of operations. We believe that borrowing temporarily or selling investments earlier than anticipated will not have a material impact on the liquidity of the Company. Payment of claims and sale of investments earlier than anticipated would have an impact on the reported level of cash flow from operating and investing activities, respectively, in our financial statements.