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:
our ability to manufacture and distribute products and services and to introduce new products gaining market acceptance on a timely basis;
As of the date of Acquisition, the Company changed its classification of equity securities held in support of a deferred compensation plan from available for sale to trading. New management made this decision to align with Prudential Financial’s accounting policy. These equity securities were fair valued on May 1, 2003 under purchase accounting and therefore there was no income statement impact for the change in classification. Such investments are now carried at fair value with changes in unrealized gains and losses reported in the Statements of Operations and Comprehensive Income, as a component of “Other income.”
We capitalize costs that vary with and are related primarily to the acquisition of new and renewal annuity contracts. These costs include primarily commissions, costs of policy issuance and underwriting and other variable expenses. We amortize these deferred policy acquisition costs, or DAC, 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. As of December 31, 2005 and 2004, DAC was $528.9 million and $300.9 million, respectively.
DAC is amortized over the expected life of the policy in proportion to gross profits. In calculating gross profits, we consider mortality, persistency, and other elements as well as rates of return on investments associated with these contracts. We regularly evaluate and adjust the related DAC balance with a corresponding charge or credit to current period earnings for the effects of our actual gross profits and changes in our assumptions regarding estimated future gross profits. DAC is sensitive to the effects of changes in our estimates of gross profits due primarily to the significant portion of gross profits that is dependent upon the total rate of return on assets held in separate account investment options, and the shorter average life of the contracts. This rate of return influences the fees we earn, costs we incur associated with minimum death benefit and other contractual guarantees specific to our variable annuity contracts, as well as other sources of profit.
From December 31, 2005 to December 31, 2004 total assets increased by $2.6 billion from $30.3 billion to $32.9 billion. Sales activity during the year ended December 31, 2005 resulted in an increase in deferred policy acquisition costs (“DAC”) and deferred sales inducements of $228.0 million and $83.0 million, respectively. Separate account assets increased by $2.8 billion, driven by market value appreciation and positive net flows. Partially offsetting these increases were decreased fixed maturities of $209.4 million and decreased short term investments of $214.3 million primarily driven by a decline in policyholders’ account balances and cash collateral for loaned securities discussed below. Additionally, the valuation of business acquired decreased $38.1 million due to amortization.
General, administrative, and other expenses increased by $66.1 million from the prior year. The increase was primarily due to an increase in the amortization of DAC and the valuation of business acquired of $40.0 million driven by a higher level of actual gross profits used to amortize DAC driven by increased fee income discussed above as well as modeling refinement partially offset by a benefit from the increased estimate of total gross profits. In addition, commissions, net of capitalization, also increased $14.3 million driven by increased trail commissions caused by growth in separate account assets and interest expense increased by $3.8 million resulting from higher borrowing levels. General expenses also increased $8.0 million from the prior year driven by increased corporate expenses.