Management’s Discussion and Analysis of Financial Condition and Results of Operations or “MD&A,” addresses the financial condition of Pruco Life Insurance Company of New Jersey as of December 31, 2007, compared with December 31, 2006, and its results of operations for the years ended December 31, 2007 and 2006.
our ability to generate favorable investment results through asset/liability management and strategic and tactical asset allocation; and
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or 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 Financial Statements could change significantly.
As prescribed by GAAP, we present our fixed maturity investments classified as available for sale at fair value in the statements of financial position. The fair values for our public fixed maturity securities are based on quoted market prices or estimates from independent pricing services. However, for our investments in private securities such as private placement fixed maturity securities, which comprised 14% of our investments as of December 31, 2007, this information is not available. For these private fixed maturities, 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 things, the credit quality of the issuer and the reduced liquidity associated with private placements. In determining the fair value of certain securities, the discounted cash flow model may also use unobservable inputs, which reflect our own assumptions about the inputs market participants would use in pricing the asset.
For our fixed maturity investments classified as available for sale, the impact of changes in fair value is recorded as an unrealized gain or loss in “Accumulated other comprehensive income (loss), net of taxes,” a separate component of equity. In addition, investments classified as available for sale are subject to our impairment review to identify when a decline in value is other than temporary. Factors we consider in determining whether a decline in value is other than temporary include: the extent (generally if greater than 20%) and the duration (generally greater than six months) of the decline; the reasons for the decline in value (credit event or interest rate related); our ability and intent to hold the investment for a period of time that will allow for a recovery of value; and the financial condition and near-term prospects of the issuer. When it is determined that a decline in value is other than temporary, the carrying value of the security is reduced to its fair value, with a corresponding charge to earnings. When it is determined that a decline in value is other than temporary, the carrying value of the security is reduced to its fair value, with a corresponding charge to earnings. When it is determined that a decline in value is other than temporary, the carrying value of the security is reduced to its fair value, with a corresponding charge to earnings. In addition, for our impairment review of asset-backed fixed maturity securities with a credit rating below AA, we forecast the prospective future cash flows of the security and determine if the present value of those cash flows, discounted using the effective yield of the most recent interest accrual rate, has decreased from the previous reporting period. When a decrease from the prior reporting period has occurred and the security’s market value is less than its carrying value, the carrying value of the security is reduced to its fair value, with a corresponding charge to earnings. In both cases, this corresponding charge to earnings is referred to as an impairment. Impairments are reflected in “Realized investment gains (losses), net” in the statements of operations and are excluded from adjusted operating income. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods
subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. Accordingly, the discount (or reduced premium) based on the new cost basis is accreted into net investment income, and included in adjusted operating income in future periods based upon the amount and timing of the expected future cash flows of the security, if the recoverable value of the investment based upon those cash flows is greater than the carrying value of the investment after the impairment. The level of impairment losses can be expected to increase when economic conditions worsen and decrease when economic conditions improve.
Commercial loans, which comprised nearly 8% of our investments as of December 31, 2007, are carried primarily at unpaid principal balances, net of unamortized premiums or discounts and an allowance for losses. This allowance includes a loan specific portion as well as a portfolio reserve for probable incurred but not specifically identified losses. The loan specific portion is based on management’s judgment as to ultimate collectibility of loan principal. The portfolio reserve is based on a number of factors, such as historical experience and portfolio diversification. Adjustments to the allowance are reflected in “Realized investment gains (losses), net,” in our statements of operations. Similar to impairment losses discussed above, the allowance for losses can be expected to increase when economic conditions worsen and decrease when economic conditions improve.
DAC associated with the term life policies of our domestic individual life insurance business is amortized in proportion to gross premiums. We evaluate the recoverability of our DAC related to these policies as part of our premium deficiency testing. If a premium deficiency exists, we reduce DAC by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the DAC balance, we then increase the reserve for future policy benefits by the excess by means of a charge to current period earnings. Generally, we do not expect significant short term deterioration in experience, and therefore do not expect significant adjustments to the related DAC.
in our future mortality rate by 1%. This information considers only the effect of changes in our mortality assumptions 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.
Tax regulations require items to be included in the tax return at different times from the items reflected in the financial statements. As a result, the effective tax rate reflected in the financial statements is different than the actual rate applied on the tax return. Some of these differences are permanent such as expenses that are not deductible in our tax return, and some differences are temporary, reversing over time, such as valuation of insurance reserves. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expenditures for which we have already taken a deduction in our tax return but have not yet recognized in our financial statements. The application
See Note 2 to the Financial Statements for a discussion of new accounting policies adopted.
Total assets increased by $415 million from $4.282 billion December 31, 2006 to $4.697 billion at December 31, 2007. Separate account assets increased by $306 million from $2.620 billion at December 31, 2006 to $2.926 billion at December 31, 2007 primarily due to market performance and positive net sales, in 2007. Commercial loans increased $53 million, from $49 million at December 31, 2006 to $102 million at December 31, 2007, as additional funds were invested in commercial loans. Cash and cash equivalents are lower by $26 million as cash used in financing activities exceeded cash provided from operating and investing activities in 2007. Deferred policy acquisition costs increased by $17 million from $256 million at December 31, 2006, to $273 million at December 31, 2007, primarily driven by capitalization of acquisition costs from the continued growth of term life insurance sales. Reinsurance recoverables increased by $52 million, as a result of continued growth in term in force covered in the Prudential Arizona Reinsurance Captive Company “PARCC” coinsurance agreement
Revenues increased by $36 million, from $129 million in 2006 to $165 million in 2007. Policy charges and fee income increased $17 million from the prior year, including $7 million due to updates in both periods of our assumptions related to the amortization of unearned revenue reserves based on the annual reviews, as discussed above. Absent this item policy charges and fee income increased $10 million in 2007, reflecting growth in our universal life insurance in force, the placing of a large COLI case to an affiliate and higher fees from growth in separate account assets resulting from market
appreciation. Premiums increased $3 million from the prior year due to growth in term life insurance business. Also contributing to this increase in revenues is lower realized losses of $12 million due to additional realized losses from the sales of fixed maturities in a rising interest rate environment in 2006. Partially offsetting this realized loss was an increase in investment income of $1 million primarily due to higher yields resulting from investment activities in a rising interest rate environment compared to 2006.
Total benefits and expenses increased by $30 million, from $79 million in 2006 to $109 million in 2007.
General, administrative and other expenses increased by $29 million from $32 million in 2006 to $61 million in 2007. The primary driver of the increase was the 2006 annual review, discussed above, which resulted in a reduction in amortization of deferred acquisition costs of $15 million. In 2007, the annual review resulted in an increase in amortization of deferred acquisition costs of $3 million. Absent the impacts of the annual reviews conducted in both periods, general, administrative, and other expenses increased $11 million in 2007 primarily due to higher new business related expenses and the placing of a large COLI case to an affiliate.