<PAGE>
The Prudential Variable Appreciable Account
Financial Statements
For the periods ended December 31, 1998
The Prudential Insurance Company of America
Consolidated Financial Statements
For the periods ended December 31, 1998
[LOGO] Prudential
<PAGE>
[LOGO] Prudential The Prudential Insurance Company of
America
751 Broad Street
Newark, New Jersey 07102-3777
Dear Policyowner:
It is a pleasure to provide you with three informative documents pertaining to
your Custom Variable Appreciable Life policy:
. The Prudential Series Fund, Inc. prospectus dated May 1, 1999
. 1998 Prudential Variable Appreciable Account Financial Statements
. 1998 Prudential Consolidated Financial Statements
Since this material contains important information about your policy, we suggest
that you keep it with your policy for future reference.
Your Asset Allocation Should Reflect Your Current Risk Tolerance and Financial
Goals
One of life's certainties is the inevitability of change. And as changes occur
in our personal and professional lives, we all need to review our financial
plans and insurance protection needs. The Contract Fund in your variable life
insurance policy includes several investment options. Since another of life's
certainties is that no one can predict the future performance of the financial
markets, we recommend that you regularly reevaluate the allocation of your net
premium dollars among your investment choices. With the assistance of
Prudential's Asset Allocation model, your Prudential Agent/Pruco Securities
Registered Representative can help you analyze your allocations and adjust them
to make them consistent with your current needs, objectives, risk tolerance and
time horizons.
Life Insurance Coverage Is A Critical Financial Asset
Your variable life insurance policy is a valuable asset and a significant
element of your financial security plan. Maintaining it is critical because of
the protection it provides to your loved ones and beneficiaries. Your Annual
Statement, as well as a policy review with your Representative, can tell you how
your investment choices are performing relative to your goals. This will help
you determine if you need to adjust the amount of your premium payments in order
to maintain your insurance coverage.
We Want to Help You Plan To Achieve Your Financial Security And Protection Goals
If you have any questions about this correspondence, please call your Prudential
Agent/Pruco Securities Registered Representative, or call (800) 778-2255, 8 a.m.
to 8 p.m. Eastern time. And, upon receipt of your Annual Statement, we suggest
that you contact your Representative for a policy review of your variable life
coverage. He or she can also help you evaluate your need for additional life
insurance protection and show you how Prudential's broad range of products and
services can help you in planning to achieve your overall financial security
goals.
Thank you for insuring with us. We appreciate having you as our customer and we
look forward to a continued relationship with you in the years to come.
Sincerely,
/s/
- ---------------------------
James J. Avery, Jr. FSA
President, Individual Life Insurance
Variable life is offered by prospectus only through Pruco Securities
Corporation, a subsidiary of The Prudential Insurance Company of America, both
located at 751 Broad Street, Newark, NJ 07102-3777.
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF NET ASSETS
December 31, 1998
SUBACCOUNTS
----------------------------------------------------------------------------------
MONEY DIVERSIFIED FLEXIBLE CONSERVATIVE
MARKET BOND EQUITY MANAGED BALANCED
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
ASSETS
Investment in The Prudential Series Fund, Inc.
Portfolios at net asset value [Note 3] ..... $ 112,731,079 $ 147,114,992 $1,516,736,886 $1,460,736,333 $1,126,162,749
-------------- -------------- -------------- -------------- --------------
Net Assets ................................... $ 112,731,079 $ 147,114,992 $1,516,736,886 $1,460,736,333 $1,126,162,749
============== ============== ============== ============== ==============
NET ASSETS, representing:
Equity of contract owners .................... $ 112,731,079 $ 147,114,992 $1,516,736,886 $1,460,736,333 $1,126,162,749
-------------- -------------- -------------- -------------- --------------
$ 112,731,079 $ 147,114,992 $1,516,736,886 $1,460,736,333 $1,126,162,749
============== ============== ============== ============== ==============
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A1
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
--------------------------------------------------------------------------------------------------------------------
ZERO COUPON HIGH ZERO COUPON
BOND YIELD STOCK EQUITY NATURAL GOVERNMENT BOND
2000 BOND INDEX INCOME RESOURCES GLOBAL INCOME 2005
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 19,961,108 $ 92,745,342 $845,861,223 $454,271,316 $100,784,964 $142,307,176 $ 82,088,176 $ 27,213,641
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 19,961,108 $ 92,745,342 $845,861,223 $454,271,316 $100,784,964 $142,307,176 $ 82,088,176 $ 27,213,641
============ ============ ============ ============ ============ ============ ============ ============
$ 19,961,108 $ 92,745,342 $845,861,223 $454,271,316 $100,784,964 $142,307,176 $ 82,088,176 $ 27,213,641
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 19,961,108 $ 92,745,342 $845,861,223 $454,271,316 $100,784,964 $142,307,176 $ 82,088,176 $ 27,213,641
============ ============ ============ ============ ============ ============ ============ ============
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</TABLE>
A2
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF NET ASSETS
December 31, 1998
SUBACCOUNTS
-------------------------------
SMALL
PRUDENTIAL CAPITALIZATION
JENNISON STOCK
PORTFOLIO PORTFOLIO
-------------- --------------
<S> <C> <C>
ASSETS
Investment in The Prudential Series Fund, Inc. .
Portfolios at net asset value [Note 3] ....... $ 203,957,589 $ 100,578,460
-------------- --------------
Net Assets .................................. $ 203,957,589 $ 100,578,460
============== ==============
NET ASSETS, representing:
Equity of contract owners ................... $ 203,957,589 $ 100,578,460
-------------- --------------
$ 203,957,589 $ 100,578,460
============== ==============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
A3
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
SUBACCOUNTS
----------------------------------------------------------------------------------
MONEY MARKET DIVERSIFIED BOND
PORTFOLIO PORTFOLIO
----------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Dividend income ............................ $ 5,267,889 $ 5,094,912 $ 4,689,159 $ 8,588,103 $ 9,043,537 $ 7,158,122
------------ ------------ ------------ ------------ ------------ -----------
EXPENSES
Charges to contract owners for assuming
mortality risk and expense risk [Note 5A] 702,791 661,235 630,761 977,226 866,520 769,815
Reimbursement for excess expenses [Note 5D] 0 0 0 0 0 0
------------ ------------ ------------ ------------ ------------ -----------
NET EXPENSES ................................. 702,791 661,235 630,761 977,226 866,520 769,815
------------ ------------ ------------ ------------ ------------ -----------
NET INVESTMENT INCOME (LOSS) ................. 4,565,098 4,433,677 4,058,398 7,610,877 8,177,017 6,388,307
------------ ------------ ------------ ------------ ------------ -----------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Capital gains distributions received ....... 0 0 0 492,608 1,452,476 0
Realized gain (loss) on shares redeemed .... 0 0 0 107,984 107,543 19,658
Net change in unrealized gain (loss) on
investments .............................. 0 0 0 242,854 (702,474) (2,104,541)
------------ ------------ ------------ ------------ ------------ -----------
NET GAIN (LOSS) ON INVESTMENTS ............... 0 0 0 843,446 857,545 (2,084,883)
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS .................. $ 4,565,098 $ 4,433,677 $ 4,058,398 $ 8,454,323 $ 9,034,562 $ 4,303,424
============ ============ ============ ============ ============ ===========
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A4
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------
EQUITY FLEXIBLE MANAGED CONSERVATIVE BALANCED
PORTFOLIO PORTFOLIO PORTFOLIO
- ---------------------------------------- ---------------------------------------- ----------------------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 27,312,284 $ 28,870,327 $ 23,448,572 $ 46,336,137 $ 38,256,221 $ 32,750,578 $ 46,034,230 $ 45,612,319 $ 35,574,962
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
10,647,094 8,895,624 6,600,231 10,109,863 8,970,935 7,402,644 7,958,450 7,210,074 6,248,856
0 0 0 0 0 0 0 0 0
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
10,647,094 8,895,624 6,600,231 10,109,863 8,970,935 7,402,644 7,958,450 7,210,074 6,248,856
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
16,665,190 19,974,703 16,848,341 36,226,274 29,285,286 25,347,934 38,075,780 38,402,245 29,326,106
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
165,422,738 73,183,544 92,436,486 147,043,667 201,042,079 106,224,518 65,867,708 110,154,176 55,843,548
14,951,173 7,311,176 755,380 2,295,592 3,097,268 487,657 1,526,727 2,680,112 627,498
(78,932,919) 158,043,072 41,805,447 (58,722,618) (37,001,732) (5,082,172) 6,236,915 (36,006,094) 10,273,250
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
101,440,992 238,537,792 134,997,313 90,616,641 167,137,615 101,630,003 73,631,350 76,828,194 66,744,296
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$118,106,182 $258,512,495 $151,845,654 $126,842,915 $196,422,901 $126,977,937 $111,707,130 $115,230,439 $ 96,070,402
============ ============ ============ ============ ============ ============ ============ ============ ============
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</TABLE>
A5
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
SUBACCOUNTS
----------------------------------------------------------------------------------
ZERO COUPON BOND 2000 HIGH YIELD BOND
PORTFOLIO PORTFOLIO
----------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Dividend income............................. $ 990,142 $ 1,012,102 $ 835,394 $ 9,308,036 $ 8,213,223 $ 7,376,933
------------ ------------ ------------ ------------ ------------ -----------
EXPENSES
Charges to contract owners for assuming
mortality risk and expense risk [Note 5A]. 144,233 141,029 143,233 697,446 618,514 532,324
Reimbursement for excess expenses [Note 5D]. (44,243) (53,201) (23,005) 0 0 0
------------ ------------ ------------ ------------ ------------ -----------
NET EXPENSES.................................. 99,990 87,828 120,228 697,446 618,514 532,324
------------ ------------ ------------ ------------ ------------ -----------
NET INVESTMENT INCOME (LOSS).................. 890,152 924,274 715,166 8,610,590 7,594,709 6,844,609
------------ ------------ ------------ ------------ ------------ -----------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Capital gains distributions received........ 267,168 804,923 0 0 0 0
Realized gain (loss) on shares redeemed..... 60,617 46,554 27,409 (243,731) 311,580 20,787
Net change in unrealized gain (loss) on
investments.................................... 153,354 (497,282) (556,648) (11,461,047) 2,620,272 581,780
------------ ------------ ------------ ------------ ------------ -----------
NET GAIN (LOSS) ON INVESTMENTS................ 481,139 354,195 (529,239) (11,704,778) 2,931,852 602,567
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS.................... $ 1,371,291 $ 1,278,469 $ 185,927 $ (3,094,188) $ 10,526,561 $7,447,176
============ ============ ============ ============ ============ ===========
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A6
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------
STOCK INDEX EQUITY INCOME NATURAL RESOURCES
PORTFOLIO PORTFOLIO PORTFOLIO
- ---------------------------------------- ---------------------------------------- ----------------------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 9,059,895 $ 8,102,242 $ 6,724,618 $ 12,342,267 $ 9,608,504 $ 9,118,093 $ 975,725 $ 757,192 $ 877,698
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
5,175,364 3,790,129 2,544,825 3,262,956 2,532,105 1,767,583 851,287 1,079,034 909,008
0 0 0 0 0 0 0 0 (16,487)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
5,175,364 3,790,129 2,544,825 3,262,956 2,532,105 1,767,583 851,287 1,079,034 892,521
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
3,884,531 4,312,113 4,179,793 9,079,311 7,076,399 7,350,510 124,438 (321,842) (14,823)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
12,847,130 17,197,911 4,749,836 27,501,162 39,390,070 9,133,917 6,263,457 16,426,552 17,021,108
6,237,945 6,786,808 263,052 (99,580) 3,982,449 171,030 (1,250,821) 1,240,093 341,761
153,992,331 113,415,557 61,075,735 (52,611,025) 59,248,683 32,816,172 (26,817,989) (35,487,893) 13,941,557
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
173,077,406 137,400,276 66,088,623 (25,209,443) 102,621,202 42,121,119 (21,805,353) (17,821,248) 31,304,426
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$176,961,937 $141,712,389 $ 70,268,416 $(16,130,132) $109,697,601 $ 49,471,629 $(21,680,915) $(18,143,090) $ 31,289,603
============ ============ ============ ============ ============ ============ ============ ============ ============
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A7
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
SUBACCOUNTS
----------------------------------------------------------------------------------
GLOBAL GOVERNMENT INCOME
PORTFOLIO PORTFOLIO
----------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Dividend income............................ $ 1,738,704 $ 1,281,804 $ 1,778,642 $ 4,520,286 $ 4,704,795 $ 4,676,803
------------ ------------ ------------ ------------ ------------ -----------
EXPENSES
Charges to contract owners for assuming
mortality risk and expense risk [Note 5A] 843,008 686,676 446,499 560,752 515,147 519,382
Reimbursement for excess expenses [Note 5D] 0 0 0 0 0 0
------------ ------------ ------------ ------------ ------------ -----------
NET EXPENSES................................. 843,008 686,676 446,499 560,752 515,147 519,382
------------ ------------ ------------ ------------ ------------ -----------
NET INVESTMENT INCOME (LOSS)................. 895,696 595,128 1,332,143 3,959,534 4,189,648 4,157,421
------------ ------------ ------------ ------------ ------------ -----------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Capital gains distributions received....... 5,918,263 5,120,114 1,298,584 0 0 0
Realized gain (loss) on shares redeemed.... 1,375,609 309,311 16,670 289,366 44,975 22,685
Net change in unrealized gain (loss) on
investments.............................. 18,668,316 (917,843) 9,125,406 1,952,252 1,925,166 (3,090,993)
------------ ------------ ------------ ------------ ------------ -----------
NET GAIN (LOSS) ON INVESTMENTS................ 25,962,188 4,511,582 10,440,660 2,241,618 1,970,141 (3,068,308)
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS................... $ 26,857,884 $ 5,106,710 $ 11,772,803 $ 6,201,152 $ 6,159,789 $ 1,089,113
============ ============ ============ ============ ============ ===========
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A8
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------
ZERO COUPON BOND 2005 PRUDENTIAL JENNISON SMALL CAPITALIZATION STOCK
PORTFOLIO PORTFOLIO PORTFOLIO
- ----------------------------------------- ---------------------------------------- ---------------------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 1,296,279 $ 1,246,707 $ 1,123,279 $ 298,391 $ 157,623 $ 64,455 $ 528,189 $ 330,650 $ 153,825
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
174,202 152,442 147,863 933,952 439,584 149,932 578,299 320,322 100,546
(55,172) (73,169) (27,318) 0 0 0 0 0 0
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
119,030 79,273 120,545 933,952 439,584 149,932 578,299 320,322 100,546
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
1,177,249 1,167,434 1,002,734 (635,561) (281,961) (85,477) (50,110) 10,328 53,279
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
29,253 489,749 246,221 2,902,977 5,052,341 0 5,935,686 4,897,323 489,855
164,197 71,812 290 453,639 525,215 0 (102,881) 46,921 (7,039)
1,406,685 526,125 (1,505,763) 42,669,927 10,743,964 3,012,624 (7,230,189) 5,112,289 2,049,209
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
1,600,135 1,087,686 (1,259,252) 46,026,543 16,321,520 3,012,624 (1,397,384) 10,056,533 2,532,025
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 2,777,384 $ 2,255,120 $ (256,518) $ 45,390,982 $ 16,039,559 $ 2,927,147 $ (1,447,494) $ 10,066,861 $2,585,304
============ ============ ============ ============ ============ ============ ============ ============ ============
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</TABLE>
A9
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF CHANGES IN NET ASSETS
For the years ended December 31, 1998, 1997 and 1996
SUBACCOUNTS
----------------------------------------------------------------------------------
MONEY DIVERSIFIED
MARKET BOND
PORTFOLIO PORTFOLIO
----------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS
Net investment income (loss)............... $ 4,565,098 $ 4,433,677 $ 4,058,398 $ 7,610,877 $ 8,177,017 $ 6,388,307
Capital gains distributions received....... 0 0 0 492,608 1,452,476 0
Realized gain (loss) on shares redeemed.... 0 0 0 107,984 107,543 19,658
Net change in unrealized gain (loss) on
investments.............................. 0 0 0 242,854 (702,474) (2,104,541)
------------ ------------ ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS.................. 4,565,098 4,433,677 4,058,398 8,454,323 9,034,562 4,303,424
------------ ------------ ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM PREMIUM PAYMENTS
AND OTHER OPERATING TRANSFERS
[Note 7]................................... 14,916,149 (6,936,043) 768,830 9,523,399 3,856,643 10,268,006
------------ ------------ ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN NET ASSETS
RETAINED IN THE ACCOUNT
[Note 8]................................... (1,854,444) (147,721) 1,422,930 15,863 (196,475) (142,209)
------------ ------------ ------------ ------------ ------------ ------------
TOTAL INCREASE (DECREASE) IN NET ASSETS...... 17,626,803 (2,650,087) 6,250,158 17,993,585 12,694,730 14,429,221
NET ASSETS
Beginning of year.......................... 95,104,276 97,754,363 91,504,205 129,121,407 116,426,677 101,997,456
------------ ------------ ------------ ------------ ------------ ------------
End of year................................ $112,731,079 $ 95,104,276 $ 97,754,363 $147,114,992 $129,121,407 $116,426,677
============ ============ ============ ============ ============ ============
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A10
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
- -----------------------------------------------------------------------------------------------------------
FLEXIBLE
EQUITY MANAGED
PORTFOLIO PORTFOLIO
- --------------------------------------------------- ----------------------------------------------------
1998 1997 1996 1998 1997 1996
- --------------- --------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
$ 16,665,190 $ 19,974,703 $ 16,848,341 $ 36,226,274 $ 29,285,286 $ 25,347,934
165,422,738 73,183,544 92,436,486 147,043,667 201,042,079 106,224,518
14,951,173 7,311,176 755,380 2,295,592 3,097,268 487,657
(78,932,919) 158,043,072 41,805,447 (58,722,618) (37,001,732) (5,082,172)
- --------------- --------------- --------------- --------------- --------------- ---------------
118,106,182 258,512,495 151,845,654 126,842,915 196,422,901 126,977,937
- --------------- --------------- --------------- --------------- --------------- ---------------
25,056,926 55,194,557 116,044,081 (15,176,695) 15,507,613 57,031,152
- --------------- --------------- --------------- --------------- --------------- ---------------
(134,891) (1,730,961) (2,717,850) (115,363) (332,076) (1,594,508)
- --------------- --------------- --------------- --------------- --------------- ---------------
143,028,217 311,976,091 265,171,885 111,550,857 211,598,438 182,414,581
1,373,708,669 1,061,732,578 796,560,693 1,349,185,476 1,137,587,038 955,172,457
- --------------- --------------- --------------- --------------- --------------- ---------------
$ 1,516,736,886 $ 1,373,708,669 $ 1,061,732,578 $ 1,460,736,333 $ 1,349,185,476 $ 1,137,587,038
=============== =============== =============== =============== =============== ===============
<CAPTION>
CONSERVATIVE
BALANCED
PORTFOLIO
- -----------------------------------------------------
1998 1997 1996
- --------------- --------------- ---------------
<C> <C> <C>
$ 38,075,780 $ 38,402,245 $ 29,326,106
65,867,708 110,154,176 55,843,548
1,526,727 2,680,112 627,498
6,236,915 (36,006,094) 10,273,250
- --------------- --------------- ---------------
111,707,130 115,230,439 96,070,402
- --------------- --------------- ---------------
(13,835,007) (5,484,215) 36,970,919
- --------------- --------------- ---------------
(57,837) 98,440 (1,143,063)
- --------------- --------------- ---------------
97,814,286 109,844,664 131,898,258
1,028,348,463 918,503,799 786,605,541
- --------------- --------------- ---------------
$ 1,126,162,749 $ 1,028,348,463 $ 918,503,799
=============== =============== ===============
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A11
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF CHANGES IN NET ASSETS
For the years ended December 31, 1998, 1997 and 1996
SUBACCOUNTS
----------------------------------------------------------------------------------
ZERO COUPON HIGH YIELD
BOND 2000 BOND
PORTFOLIO PORTFOLIO
----------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS
Net investment income (loss)................ $ 890,152 $ 924,274 $ 715,166 $ 8,610,590 $ 7,594,709 $ 6,844,609
Capital gains distributions received........ 267,168 804,923 0 0 0 0
Realized gain (loss) on shares redeemed..... 60,617 46,554 27,409 (243,731) 311,580 20,787
Net change in unrealized gain (loss) on
investments............................... 153,354 (497,282) (556,648) (11,461,047) 2,620,272 581,780
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS................... 1,371,291 1,278,469 185,927 (3,094,188) 10,526,561 7,447,176
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM PREMIUM PAYMENTS
AND OTHER OPERATING TRANSFERS
[Note 7].................................... (1,283,829) (1,405,154) (613,550) 4,214,068 374,682 5,326,899
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RETAINED IN THE ACCOUNT [Note 8]............ (8,240) (63,959) 33,778 (42,474) (110,168) 52,425
------------ ------------ ------------ ------------ ------------ -----------
TOTAL INCREASE (DECREASE) IN NET ASSETS....... 79,222 (190,644) (393,845) 1,077,406 10,791,075 12,826,500
NET ASSETS
Beginning of year........................... 19,881,886 20,072,530 20,466,375 91,667,936 80,876,861 68,050,361
------------ ------------ ------------ ------------ ------------ -----------
End of year................................. $ 19,961,108 $ 19,881,886 $ 20,072,530 $ 92,745,342 $ 91,667,936 $80,876,861
============ ============ ============ ============ ============ ===========
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A12
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
- -----------------------------------------------------------------------------------------------------------------------------
STOCK EQUITY NATURAL
INDEX INCOME RESOURCES
PORTFOLIO PORTFOLIO PORTFOLIO
- ----------------------------------------- ---------------------------------------- ---------------------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 3,884,531 $ 4,312,113 $ 4,179,793 $ 9,079,311 $ 7,076,399 $ 7,350,510 $ 124,438 $ (321,842) $ (14,823)
12,847,130 17,197,911 4,749,836 27,501,162 39,390,070 9,133,917 6,263,457 16,426,552 17,021,108
6,237,946 6,786,808 263,052 (99,580) 3,982,449 171,030 (1,250,821) 1,240,093 341,761
153,992,330 113,415,557 61,075,735 (52,611,025) 59,248,683 32,816,172 (26,817,989) (35,487,893) 13,941,557
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
176,961,937 141,712,389 70,268,416 (16,130,132) 109,697,601 49,471,629 (21,680,915) (18,143,090) 31,289,603
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
46,615,330 58,525,779 55,125,681 29,232,315 36,671,034 23,125,635 (8,089,480) 2,933,126 13,900,701
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
111,800 (910,143) 82,144 139,884 (393,762) (711,051) (97,825) (148,013) (277,180)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
223,689,067 199,328,025 125,476,241 13,242,067 145,974,873 71,886,213 (29,868,220) (15,357,977) 44,913,124
622,172,156 422,844,131 297,367,890 441,029,249 295,054,376 223,168,163 130,653,184 146,011,161 101,098,037
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$845,861,223 $622,172,156 $422,844,131 $454,271,316 $441,029,249 $295,054,376 $100,784,964 $130,653,184 $146,011,161
============ ============ ============ ============ ============ ============ ============ ============ ============
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A13
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
STATEMENTS OF CHANGES IN NET ASSETS
For the years ended December 31, 1998, 1997 and 1996
SUBACCOUNTS
----------------------------------------------------------------------------------
GOVERNMENT
GLOBAL INCOME
PORTFOLIO PORTFOLIO
----------------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS
Net investment income (loss)................ $ 895,696 $ 595,128 $ 1,332,143 $ 3,959,534 $ 4,189,648 $ 4,157,421
Capital gains distributions received........ 5,918,263 5,120,114 1,298,584 0 0 0
Realized gain (loss) on shares redeemed..... 1,375,609 309,311 16,670 289,366 44,975 22,685
Net change in unrealized gain (loss) on
investments............................... 18,668,316 (917,843) 9,125,406 1,952,252 1,925,166 (3,090,993)
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS................... 26,857,884 5,106,710 11,772,803 6,201,152 6,159,789 1,089,113
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM PREMIUM PAYMENTS
AND OTHER OPERATING TRANSFERS [Note 7]...... 7,049,239 17,556,139 24,827,377 1,634,315 (4,821,038) (1,166,024)
------------ ------------ ------------ ------------ ------------ -----------
NET INCREASE (DECREASE) IN NET ASSETS
RETAINED IN THE ACCOUNT [Note 8]............ (110,095) (317,463) (137,878) (9,785) (923,259) 788,406
------------ ------------ ------------ ------------ ------------ -----------
TOTAL INCREASE (DECREASE) IN NET ASSETS....... 33,797,028 22,345,386 36,462,302 7,825,682 415,492 711,495
NET ASSETS
Beginning of year.......................... 108,510,148 86,164,762 49,702,460 74,262,494 73,847,002 73,135,507
------------ ------------ ------------ ------------ ------------ -----------
End of year................................ $142,307,176 $108,510,148 $ 86,164,762 $ 82,088,176 $ 74,262,494 $73,847,002
============ ============ ============ ============ ============ ===========
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A14
<PAGE>
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------
ZERO COUPON PRUDENTIAL SMALL CAPITALIZATION
BOND 2005 JENNISON STOCK
PORTFOLIO PORTFOLIO PORTFOLIO
----------------------------------------- ---------------------------------------- -------------------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 1,177,249 $ 1,167,434 $ 1,002,734 $ (635,561) $ (281,961) $ (85,477) $ (50,110) $ 10,328 $ 53,279
29,253 489,749 246,221 2,902,977 5,052,341 0 5,935,686 4,897,323 489,855
164,197 71,812 290 453,639 525,215 0 (102,881) 46,921 (7,039)
1,406,685 526,125 (1,505,763) 42,669,927 10,743,964 3,012,624 (7,230,189) 5,112,289 2,049,209
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
2,777,384 2,255,120 (256,518) 45,390,982 16,039,559 2,927,147 (1,447,494) 10,066,861 2,585,304
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
1,198,605 (1,177,300) 1,428,479 67,125,943 34,918,336 30,275,275 26,760,022 37,146,522 20,015,548
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
(11,329) (648,770) 484,066 9,553 (773,643) 385,656 (201,407) (151,200) (22,002)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
3,964,660 429,050 1,656,027 112,526,478 50,184,252 33,588,078 25,111,121 47,062,183 22,578,850
23,248,981 22,819,931 21,163,904 91,431,111 41,246,859 7,658,781 75,467,339 28,405,156 5,826,306
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 27,213,641 $ 23,248,981 $ 22,819,931 $203,957,589 $ 91,431,111 $ 41,246,859 $100,578,460 $ 75,467,339 $ 28,405,156
============ ============ ============ ============ ============ ============ ============ ============ ============
SEE NOTES TO FINANCIAL STATEMENTS ON PAGES A16 THROUGH A23
</TABLE>
A15
<PAGE>
NOTES TO FINANCIAL STATEMENTS OF
THE VARIABLE APPRECIABLE LIFE SUBACCOUNTS
OF THE PRUDENTIAL
VARIABLE APPRECIABLE ACCOUNT
December 31, 1998
NOTE 1: GENERAL
The Prudential Variable Appreciable Account (the "Account") of The
Prudential Insurance Company of America ("Prudential") was established
on August 11, 1987 by a resolution of Prudential's Board of Directors
in conformity with insurance laws of the State of New Jersey. The
assets of the Account are segregated from Prudential's other assets.
Proceeds from the purchases of Prudential Variable Appreciable Life
("PVAL") and Prudential Survivorship Preferred ("SVUL") contracts are
invested in the Account.
The Account is registered under the Investment Company Act of 1940, as
amended, as a unit investment trust. There are fifteen subaccounts
within the Account available to PVAL and SVUL contract owners, each of
which invests only in a corresponding portfolio of The Prudential
Series Fund, Inc. (the "Series Fund"). The Series Fund is a diversified
open-end management investment company, and is managed by Prudential.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements are prepared in conformity with
generally accepted accounting principles ("GAAP"). The preparation of
the financial statements, in conformity with GAAP, requires management
to make estimates and assumptions that affect the reported amounts and
disclosures. Actual results could differ from those estimates.
Investments -- The investments in shares of the Series Fund are stated
at the net asset value of the respective portfolio.
Security Transactions -- Realized gains and losses on security
transactions are reported on an average cost basis. Purchase and sale
transactions are recorded as of the trade date of the security being
purchased or sold.
Distributions Received -- Dividend and capital gain distributions
received are reinvested in additional shares of the Series Fund and are
recorded on the ex-dividend date.
A16
<PAGE>
NOTE 3: INVESTMENT INFORMATION FOR THE PRUDENTIAL SERIES FUND, INC. PORTFOLIOS
The net asset value per share (rounded) for each portfolio of the
Series Fund, the number of shares of each portfolio held by the
subaccounts and the aggregate cost of investments in such shares at
December 31, 1998 were as follows:
<TABLE>
<CAPTION>
PORTFOLIOS
----------------------------------------------------------------------------------
MONEY DIVERSIFIED FLEXIBLE CONSERVATIVE
MARKET BOND EQUITY MANAGED BALANCED
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Number of shares: 11,273,108 13,300,129 51,177,484 88,204,668 74,676,455
Net asset value per share (rounded): $ 10.00 $ 11.06 $ 29.64 $ 16.56 $ 15.08
Cost: $ 112,731,079 $ 145,740,364 $1,245,561,920 $1,470,353,555 $1,105,257,789
<CAPTION>
PORTFOLIOS (CONTINUED)
----------------------------------------------------------------------------------
ZERO
COUPON HIGH
BOND YIELD STOCK EQUITY NATURAL
2000 BOND INDEX INCOME RESOURCES
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Number of shares: 1,567,216 12,867,179 22,412,857 22,676,693 8,410,339
Net asset value per share (rounded): $ 12.74 $ 7.21 $ 37.74 $ 20.03 $ 11.98
Cost: $ 19,800,887 $ 102,198,960 $ 432,406,040 $ 398,053,240 $ 131,521,429
<CAPTION>
PORTFOLIOS (CONTINUED)
----------------------------------------------------------------------------------
ZERO
COUPON SMALL
GOVERNMENT BOND PRUDENTIAL CAPITALIZATION
GLOBAL INCOME 2005 JENNISON STOCK
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Number of shares: 6,726,280 6,915,245 2,024,737 8,531,342 6,837,133
Net asset value per share (rounded): $ 21.16 $ 11.87 $ 13.44 $ 23.91 $ 14.71
Cost: $ 112,640,398 $ 78,556,515 $ 24,500,695 $ 147,249,669 $ 100,465,342
</TABLE>
NOTE 4: CONTRACT OWNER UNIT INFORMATION
Outstanding contract owner units, unit values and total value of
contract owner equity at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
SUBACCOUNTS
------------------------------------------------------------------------------
MONEY DIVERSIFIED FLEXIBLE CONSERVATIVE
MARKET BOND EQUITY MANAGED BALANCED
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Contract Owner Units Outstanding (PVAL) 43,275,555 40,203,520 196,836,394 266,548,472 215,680,064
Unit Value (PVAL) ..................... $ 1.66471 $ 2.31632 $ 4.66450 $ 3.37370 $ 2.83251
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (PVAL) .......... $ 72,041,250 $ 93,124,216 $ 918,143,358 $ 899,254,580 $ 610,915,939
-------------- -------------- -------------- -------------- --------------
Contract Owner Units Outstanding
(PVAL $100,000+ face) ............... 18,469,132 23,157,212 130,171,874 170,317,986 186,242,003
Unit Value (PVAL $100,000+ face) ...... $ 1.61689 $ 2.24914 $ 4.53028 $ 3.27632 $ 2.75065
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (PVAL
$100,000+ face) ..................... $ 29,862,556 $ 52,083,812 $ 589,715,035 $ 558,016,223 $ 512,286,566
-------------- -------------- -------------- -------------- --------------
Contract Owner Units Outstanding (SVUL) 9,533,065 1,604,230 5,533,875 2,370,679 2,109,337
Unit Value (SVUL) ..................... $ 1.13576 $ 1.18871 $ 1.60439 $ 1.46183 $1.40340
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (SVUL) .......... $ 10,827,273 $ 1,906,964 $ 8,878,493 $ 3,465,530 $ 2,960,244
-------------- -------------- -------------- -------------- --------------
TOTAL CONTRACT OWNER EQUITY ........... $ 112,731,079 $ 147,114,992 $1,516,736,886 $1,460,736,333 $1,126,162,749
============== ============== ============== ============== ==============
</TABLE>
A17
<PAGE>
NOTE 4: CONTRACT OWNER UNIT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
------------------------------------------------------------------------------
ZERO COUPON HIGH YIELD STOCK EQUITY NATURAL
BOND 2000 BOND INDEX INCOME RESOURCES
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Contract Owner Units Outstanding (PVAL) 4,582,436 23,784,077 93,930,360 75,321,133 27,332,575
Unit Value (PVAL) ..................... $ 2.59938 $ 2.30936 $ 5.63518 $ 4.05205 $ 2.18644
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (PVAL) .......... $ 11,911,491 $ 54,925,995 $ 529,314,487 $ 305,204,997 $ 59,761,036
-------------- -------------- -------------- -------------- --------------
Contract Owner Units Outstanding
(PVAL $100,000+ face) ............... 3,189,268 15,884,568 56,008,717 36,620,899 19,225,267
Unit Value (PVAL $100,000+ face) ...... $ 2.52397 $ 2.24346 $ 5.47186 $ 3.93413 $ 2.12355
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (PVAL
$100,000+ face) ..................... $ 8,049,617 $ 35,636,392 $ 306,471,859 $ 144,071,378 $ 40,825,817
-------------- -------------- -------------- -------------- --------------
Contract Owner Units Outstanding (SVUL) -- 1,831,645 4,821,807 3,091,081 215,207
Unit Value (SVUL) ..................... -- $ 1.19180 $ 2.08944 $ 1.61592 $ 0.92056
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (SVUL) .......... -- $ 2,182,955 $ 10,074,877 $ 4,994,941 $ 198,111
-------------- -------------- -------------- -------------- --------------
TOTAL CONTRACT OWNER EQUITY ........... $ 19,961,108 $ 92,745,342 $ 845,861,223 $ 454,271,316 $ 100,784,964
============== ============== ============== ============== ==============
<CAPTION>
SUBACCOUNTS (CONTINUED)
------------------------------------------------------------------------------
SMALL
GOVERNMENT ZERO COUPON PRUDENTIAL CAPITALIZATION
GLOBAL INCOME BOND 2005 JENNISON STOCK
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Contract Owner Units Outstanding (PVAL) 59,733,321 23,503,402 7,001,022 57,301,215 42,365,015
Unit Value (PVAL) ..................... $ 1.75630 $ 2.14801 $ 2.65130 $ 2.54336 $ 1.74567
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (PVAL) .......... $ 104,909,632 $ 50,485,543 $ 18,561,809 $ 145,737,617 $ 73,955,335
-------------- -------------- -------------- -------------- --------------
Contract Owner Units Outstanding
(PVAL $100,000+ face) ............... 18,348,364 14,941,197 3,336,001 20,322,932 11,948,496
Unit Value (PVAL $100,000+ face) ...... $ 1.73223 $ 2.08688 $ 2.57596 $ 2.51579 $ 1.72646
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (PVAL
$100,000+ face) ..................... $ 31,783,586 $ 31,180,485 $ 8,593,405 $ 51,128,228 $ 20,628,601
-------------- -------------- -------------- -------------- --------------
Contract Owner Units Outstanding (SVUL) 3,609,961 352,577 47,480 3,235,344 3,942.469
Unit Value (SVUL) ..................... $ 1.55513 $ 1.19732 $ 1.23056 $ 2.19196 $ 1.52050
-------------- -------------- -------------- -------------- --------------
Contract Owner Equity (SVUL) .......... $ 5,613,958 $ 422,148 $ 58,427 $ 7,091,744 $ 5,994,524
-------------- -------------- -------------- -------------- --------------
TOTAL CONTRACT OWNER EQUITY ........... $ 142,307,176 $ 82,088,176 $ 27,213,641 203,957,589 $ 100,578,460
============= ============== ============== ============== --------------
</TABLE>
NOTE 5: CHARGES AND EXPENSES
A. Mortality Risk and Expense Risk Charges
The mortality risk and expense risk charges, at an effective annual
rate of 0.90%, is applied daily against the net assets representing
equity of PVAL contract owners held in each subaccount. For contract
owners investing in PVAL with face amounts of $100,000 or more the
annual rate is 0.60%. For contract owners investing in SVUL the
annual rate is 0.90%. Mortality risk is that contract owners may not
live as long as estimated and expense risk is that the cost of
issuing and administering the policies may exceed related charges by
Prudential.
B. Deferred Sales Charge
A deferred sales charge is imposed upon surrenders of certain
variable life insurance contracts to compensate Prudential for sales
and other marketing expenses. The amount of any sales charge will
depend on the number of years that have elapsed since the contract
was issued. No sales charge will be imposed after the tenth year of
the contract. No sales charge will be imposed on death benefits.
A18
<PAGE>
NOTE 5: CHARGES AND EXPENSES (CONTINUED)
C. Partial Withdrawal Charge
A charge is imposed by Prudential on partial withdrawals of the cash
surrender value. A charge equal to the lesser of $25 or 2% for SVUL
and PVUL and $15 or 2% for PVAL will be made in connection with each
partial withdrawal of the cash surrender value of a contract.
D. Expense Reimbursement
PVAL contracts are reimbursed by Prudential, on a non-guaranteed
basis, for expenses incurred by the Series Fund in excess of the
effective rate of 0.40% for all Zero Coupon Bond Portfolios, 0.45%
for the Stock Index Portfolio, 0.50% for the Equity Income
Portfolio, 0.55% for the Natural Resources Portfolio, and 0.65% for
the High Yield Bond Portfolio of the average daily net assets of
these portfolios.
SVUL contracts are reimbursed by Prudential, on a non-guaranteed
basis, for expenses incurred by the Series Fund in excess of the
effective rate of 0.40% of the average daily net assets of the
portfolio of each of the Zero Coupon Bond Portfolios.
E. Cost of Insurance Charges
Contract owners contributions are subject to certain deductions
prior to being invested in the Account. The deductions are for (1)
transaction costs which are deducted from each premium payment for
PVAL and PVUL, to cover premium collection and processing costs; (2)
state premium taxes; (3) sales charges which are deducted in order
to compensate Prudential for the cost of selling the contract.
Contracts are also subject to monthly charges for the costs of
administering the contract and to compensate Prudential for the
guaranteed minimum death benefit risk.
NOTE 6: TAXES
Prudential is taxed as a "life insurance company" as defined by the
Internal Revenue Code and the results of operations of the Account form
a part of Prudential's consolidated federal tax return. Under current
federal law, no federal income taxes are payable by the Account. As
such, no provision for tax liability has been recorded in these
financial statements.
NOTE 7: NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM PREMIUM PAYMENTS
AND OTHER OPERATING TRANSFERS
The following amounts represent contract owner activity components for
the years ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
SUBACCOUNTS
------------------------------------------------------------------
MONEY MARKET DIVERSIFIED BOND
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $ 37,611,988 $ 43,029,352 $ 26,569,268 $ 27,918,752
Policy Loans ....................................... (2,736,768) (2,616,136) (3,179,538) (2,676,866)
Policy Loan Repayment and Interest ................. 1,950,095 1,685,370 1,591,062 1,259,455
Surrenders, Withdrawals and Death Benefits ......... (9,187,944) (11,469,314) (7,722,756) (7,179,534)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ (4,007,277) (27,263,357) 3,018,103 (3,556,460)
Administrative and Other Charges ................... (8,713,945) (10,301,958) (10,752,740) (11,908,704)
------------ ------------ ------------ ------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ 14,916,149 $ (6,936,043) $ 9,523,399 $ 3,856,643
============ ============ ============ ============
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------
EQUITY FLEXIBLE MANAGED
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $285,120,763 $293,586,658 $206,491,305 $230,098,301
Policy Loans ....................................... (45,013,313) (36,815,052) (34,928,110) (29,768,329)
Policy Loan Repayment and Interest ................. 21,138,295 15,156,086 17,294,994 13,061,811
Surrenders, Withdrawals and Death Benefits ......... (97,071,175) (79,836,234) (79,498,303) (69,955,243)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ (7,299,784) 281,061 (18,229,089) (12,348,231)
Administrative and Other Charges ................... (131,817,860) (137,177,962) (106,307,492) (115,580,696)
------------ ------------ ------------ ------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ 25,056,926 $ 55,194,557 $(15,176,695) $ 15,507,613
============ ============ ============ ============
</TABLE>
A19
<PAGE>
NOTE 7: NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM PREMIUM PAYMENTS
AND OTHER OPERATING TRANSFERS (CONTINUED)
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------
CONSERVATIVE BALANCED ZERO COUPON BOND 2000
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $ 172,963,578 $ 193,920,159 $ 3,242,362 $ 4,066,622
Policy Loans ....................................... (24,402,529) (21,017,180) (644,425) (515,179)
Policy Loan Repayment and Interest ................. 13,921,518 10,130,000 360,153 224,553
Surrenders, Withdrawals and Death Benefits ......... (68,346,109) (68,407,322) (1,526,453) (1,236,692)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ (16,607,607) (19,240,097) (1,096,463) (1,986,651)
Administrative and Other Charges ................... (91,363,858) (100,869,775) (1,619,003) (1,957,807)
------------- ------------- ------------- -------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ (13,835,007) $ (5,484,215) $ (1,283,829) $ (1,405,154)
============= ============= ============= =============
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------
HIGH YIELD BOND STOCK INDEX
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $ 20,544,444 $ 19,451,504 $ 139,848,176 $ 126,688,004
Policy Loans ....................................... (2,652,877) (2,378,667) (21,632,900) (15,814,797)
Policy Loan Repayment and Interest ................. 1,492,709 1,433,405 8,895,587 5,919,148
Surrenders, Withdrawals and Death Benefits ......... (7,617,762) (6,747,487) (40,266,311) (32,499,126)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ 945,487 (2,355,030) 22,168,188 30,361,425
Administrative and Other Charges ................... (8,497,933) (9,029,043) (62,397,410) (56,128,875)
------------- ------------- ------------- -------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ 4,214,068 $ 374,682 $ 46,615,330 $ 58,525,779
============= ============= ============= =============
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------
EQUITY INCOME NATURAL RESOURCES
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $ 95,299,141 $ 79,016,436 $ 29,732,123 $ 35,927,519
Policy Loans ....................................... (12,921,751) (9,558,454) (3,757,335) (4,989,959)
Policy Loan Repayment and Interest ................. 5,682,713 3,893,428 2,389,809 2,524,073
Surrenders, Withdrawals and Death Benefits ......... (27,141,623) (21,564,128) (9,543,364) (10,791,367)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ 9,043,514 21,482,832 (15,621,028) (3,663,884)
Administrative and Other Charges ................... (40,729,679) (36,599,080) (11,289,685) (16,073,256)
------------- ------------- ------------- -------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ 29,232,315 $ 36,671,034 $ (8,089,480) $ 2,933,126
============= ============= ============= =============
</TABLE>
A20
<PAGE>
NOTE 7: NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM PREMIUM PAYMENTS
AND OTHER OPERATING TRANSFERS (CONTINUED)
<TABLE>
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------
GLOBAL GOVERNMENT INCOME
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $ 35,377,261 $ 34,211,689 $ 13,880,043 $ 15,732,416
Policy Loans ....................................... (3,157,015) (2,628,076) (1,989,148) (1,668,544)
Policy Loan Repayment and Interest ................. 1,774,955 1,262,980 898,042 767,258
Surrenders, Withdrawals and Death Benefits ......... (8,032,750) (7,075,480) (5,652,510) (5,308,280)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ (6,124,691) 4,870,997 1,151,981 (6,634,816)
Administrative and Other Charges ................... (12,788,521) (13,085,971) (6,654,093) (7,709,072)
------------- ------------- ------------- -------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ 7,049,239 $ 17,556,139 $ 1,634,315 $ (4,821,038)
============= ============= ============= =============
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------
ZERO COUPON BOND 2005 PRUDENTIAL JENNISON
PORTFOLIO PORTFOLIO
------------------------------ ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Contract Owner Net Payments ........................ $ 4,711,062 $ 5,574,118 $ 57,263,567 $ 34,294,641
Policy Loans ....................................... (669,881) (467,791) (4,014,420) (1,732,453)
Policy Loan Repayment and Interest ................. 324,154 216,018 1,563,575 744,576
Surrenders, Withdrawals and Death Benefits ......... (1,903,102) (1,546,854) (7,435,590) (3,227,110)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options ............................ 1,015,999 (2,416,503) 39,232,682 16,630,147
Administrative and Other Charges ................... (2,279,627) (2,536,288) (19,483,871) (11,791,465)
------------- ------------- ------------- -------------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $ 1,198,605 $ (1,177,300) $ 67,125,943 $ 34,918,336
============= ============= ============= =============
<CAPTION>
SUBACCOUNTS (CONTINUED)
----------------------------
SMALL CAPITALIZATION STOCK
PORTFOLIO
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Contract Owner Net Payments......................... $36,924,377 $24,433,471
Policy Loans........................................ (2,138,180) (1,222,173)
Policy Loan Repayment and Interest.................. 1,083,949 675,140
Surrenders, Withdrawals and Death Benefits.......... (4,861,386) (2,326,066)
Net Transfers From (To) Other Subaccounts
or Fixed Rate Options............................. 7,146,825 23,570,817
Administrative and Other Charges.................... (11,395,563) (7,984,667)
----------- -----------
Net Increase (Decrease) in Net Assets Resulting from
Premium Payments and Other Operating Transfers ... $26,760,022 $37,146,522
=========== ===========
</TABLE>
NOTE 8: NET INCREASE (DECREASE) IN NET ASSETS RETAINED IN THE ACCOUNT
The increase (decrease) in net assets retained in the account
represents the net contributions (withdrawals) of Prudential to (from)
the Account. Effective October 13, 1998 Prudential no longer maintains
a position in the account. Previously, Prudential maintained a position
in the Account for liquidity purposes including unit purchases and
redemptions, fund share transactions and expense processing.
A21
<PAGE>
NOTE 9: UNIT ACTIVITY
Transactions in units (including transfers among subaccounts) for the
years ended December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
SUBACCOUNTS
--------------------------------------------------------------------------------------
MONEY DIVERSIFIED
MARKET BOND EQUITY
PORTFOLIO PORTFOLIO PORTFOLIO
-------------------------- -------------------------- --------------------------
1998 1997 1998 1997 1998 1997
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Contract Owner Contributions: 69,014,332 65,667,687 19,897,577 16,213,787 81,572,816 92,473,729
Contract Owner Redemptions: (57,752,616) (69,425,851) (15,092,779) (14,250,810) (74,174,443) (76,628,697)
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------------------------
FLEXIBLE CONSERVATIVE ZERO COUPON
MANAGED BALANCED BOND 2000
PORTFOLIO PORTFOLIO PORTFOLIO
-------------------------- -------------------------- ------------------------
1998 1997 1998 1997 1998 1997
----------- ----------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Contract Owner Contributions: 76,938,185 93,973,164 78,380,210 93,048,913 1,980,913 1,934,757
Contract Owner Redemptions: (81,055,189) (87,813,519) (82,911,926) (94,880,956) (2,493,753) (2,549,332)
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------------------------
HIGH YIELD STOCK
BOND INDEX EQUITY INCOME
PORTFOLIO PORTFOLIO PORTFOLIO
-------------------------- -------------------------- -------------------------
1998 1997 1998 1997 1998 1997
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Contract Owner Contributions: 19,318,322 17,186,033 45,264,098 50,408,149 34,330,488 34,569,866
Contract Owner Redemptions: (16,933,871) (16,878,090) (34,390,053) (34,222,528) (26,544,454) (24,004,754)
<CAPTION>
SUBACCOUNTS (CONTINUED)
-------------------------------------------------------------------------------------
NATURAL GOVERNMENT
RESOURCES GLOBAL INCOME
PORTFOLIO PORTFOLIO PORTFOLIO
-------------------------- -------------------------- -------------------------
1998 1997 1998 1997 1998 1997
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Contract Owner Contributions: 15,093,093 18,586,440 32,534,226 37,198,997 12,383,025 10,260,445
Contract Owner Redemptions: (18,219,964) (17,455,643) (27,960,335) (24,567,571) (11,507,261) (12,866,478)
<CAPTION>
SUBACCOUNTS (CONTINUED)
------------------------------------------------------------------------------------
SMALL
CAPITALIZATION
ZERO COUPON BOND 2005 PRUDENTIAL JENNISON STOCK
PORTFOLIO PORTFOLIO PORTFOLIO
------------------------- -------------------------- -------------------------
1998 1997 1998 1997 1998 1997
---------- ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Contract Owner Contributions: 3,651,972 2,986,424 53,654,104 36,782,725 38,172,591 38,237,386
Contract Owner Redemptions: (3,174,685) (3,539,701) (22,113,796) (16,099,947) (22,883,043) (15,077,042)
</TABLE>
A22
<PAGE>
NOTE 10: PURCHASES AND SALES OF INVESTMENTS
The aggregate costs of purchases and proceeds from sales of investments
in the Series Fund for the year ended December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
PORTFOLIOS
---------------------------------------------------------------------------------------
MONEY DIVERSIFIED FLEXIBLE CONSERVATIVE
MARKET BOND EQUITY MANAGED BALANCED
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Purchases ......... $ 57,177,894 $ 15,015,417 $ 72,079,382 $ 16,973,713 $ 11,684,173
Sales ............. $(44,818,980) $ (6,242,732) $(55,820,468) $(40,983,032) $(32,494,317)
<CAPTION>
PORTFOLIOS (CONTINUED)
----------------------------------------------------------------------------------------
ZERO COUPON HIGH YIELD STOCK EQUITY NATURAL
BOND 2000 BOND INDEX INCOME RESOURCES
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Purchases ......... $ 1,220,018 $ 19,316,751 $ 67,429,443 $ 43,196,936 $ 2,582,880
Sales ............. $ (2,582,019) $(15,842,603) $(25,048,171) $(16,697,526) $(11,602,393)
<CAPTION>
PORTFOLIOS (CONTINUED)
-----------------------------------------------------------------------------------------
SMALL
GOVERNMENT ZERO COUPON PRUDENTIAL CAPITALIZATION
GLOBAL INCOME BOND 2005 JENNISON STOCK
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Purchases ......... $ 16,771,209 $ 8,068,432 $ 2,927,654 $ 69,593,982 $ 34,436,602
Sales ............. $(10,675,075) $ (6,975,097) $ (1,818,752) $ (3,377,329) $ (8,456,285)
</TABLE>
NOTE 11: RELATED PARTY TRANSACTIONS
Prudential has purchased multiple PVAL contracts insuring the lives of
certain employees. Prudential is the owner and beneficiary of the
contracts. There were no net premium payments for the year ended
December 31, 1998. Equity of contract owners in the Flexible Managed
subaccount at December 31, 1998 includes approximately $259.7 million
owned by Prudential.
A23
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Contract Owners of the Variable Appreciable Life Subaccounts of the
Prudential Variable Appreciable Account
and the Board of Directors of
The Prudential Insurance Company of America
In our opinion, the accompanying statements of net assets and the related
statements of operations and of changes in net assets present fairly, in all
material respects, the financial position of the subaccounts (Money Market
Portfolio, Diversified Bond Portfolio, Equity Portfolio, Flexible Managed
Portfolio, Conservative Balanced Portfolio, Zero Coupon Bond 2000 Portfolio,
High Yield Bond Portfolio, Stock Index Portfolio, Equity Income Portfolio,
Natural Resources Portfolio, Global Portfolio, Government Income Portfolio, Zero
Coupon Bond 2005 Portfolio, Prudential Jennison Portfolio and Small
Capitalization Stock Portfolio) of the Variable Appreciable Life Subaccounts of
the Prudential Variable Appreciable Account at December 31, 1998, the results of
each of their operations and the changes in each of their net assets for each of
the three years in the period then ended, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of The
Prudential Insurance Company of America's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with generally
accepted auditing standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of shares owned at December 31, 1998,
provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
March 19, 1999
A24
THE PRUDENTIAL INSURANCE
COMPANY OF AMERICA
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
DECEMBER 31, 1998 AND 1997
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Policyholders of
The Prudential Insurance Company of America
In our opinion, the accompanying consolidated statements of financial position
and the related consolidated statements of operations, of changes in equity and
of cash flows present fairly, in all material respects, the financial position
of The Prudential Insurance Company of America and its subsidiaries at December
31, 1998 and 1997, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 26, 1999
2
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 1998 AND 1997 (IN MILLIONS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
ASSETS
Fixed maturities:
Available for sale, at fair value (amortized cost, 1998: $76,997; 1997: $71,496) $ 80,158 $ 75,270
Held to maturity, at amortized cost (fair value, 1998: $17,906; 1997: $19,894) 16,848 18,700
Trading account assets, at fair value 8,888 6,347
Equity securities, available for sale, at fair value (cost, 1998: $2,583; 1997: $2,376) 2,759 2,810
Mortgage loans on real estate 16,495 16,004
Investment real estate 801 1,519
Policy loans 7,476 7,034
Securities purchased under agreements to resell 10,252 8,661
Cash collateral for borrowed securities 5,622 5,047
Other long-term investments 2,658 2,489
Short-term investments 9,781 12,106
--------- ---------
Total investments 161,738 155,987
Cash 1,943 1,859
Accrued investment income 1,795 1,909
Broker-dealer related receivables 10,142 8,442
Deferred policy acquisition costs 6,462 6,083
Other assets 15,721 11,452
Separate Account assets 81,621 73,839
--------- ---------
TOTAL ASSETS $ 279,422 $ 259,571
========= =========
LIABILITIES AND EQUITY
LIABILITIES
Future policy benefits $ 69,129 $ 67,367
Policyholders' account balances 30,974 33,246
Unpaid claims and claim adjustment expenses 3,860 4,864
Policyholders' dividends 1,444 1,269
Securities sold under agreements to repurchase 21,486 12,347
Cash collateral for loaned securities 7,132 14,117
Income taxes payable 785 500
Broker-dealer related payables 6,530 3,338
Securities sold but not yet purchased 5,771 3,648
Other liabilities 16,169 14,659
Short-term debt 10,082 6,774
Long-term debt 4,734 4,273
Separate Account liabilities 80,931 73,451
--------- ---------
Total liabilities 259,027 239,853
--------- ---------
COMMITMENTS AND CONTINGENCIES (SEE NOTE 16)
EQUITY
Accumulated other comprehensive income 1,232 1,661
Retained earnings 19,163 18,057
--------- ---------
Total equity 20,395 19,718
--------- ---------
TOTAL LIABILITIES AND EQUITY $ 279,422 $ 259,571
========= =========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN MILLIONS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES
Premiums $ 9,024 $ 9,005 $ 9,999
Policy charges and fee income 1,462 1,434 1,490
Net investment income 9,520 9,456 9,461
Realized investment gains, net 2,630 2,168 1,128
Commissions and other income 4,451 4,481 4,512
-------- -------- --------
Total revenues 27,087 26,544 26,590
-------- -------- --------
BENEFITS AND EXPENSES
Policyholders' benefits 9,976 10,076 11,094
Interest credited to policyholders' account balances 1,806 2,044 2,251
Dividends to policyholders 2,478 2,422 2,339
General and administrative expenses 9,720 8,992 8,956
Sales practices remedies 510 1,640 410
-------- -------- --------
Total benefits and expenses 24,490 25,174 25,050
-------- -------- --------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 2,597 1,370 1,540
-------- -------- --------
Income taxes
Current 1,185 101 556
Deferred (215) 306 (376)
-------- -------- --------
970 407 180
-------- -------- --------
INCOME FROM CONTINUING OPERATIONS 1,627 963 1,360
-------- -------- --------
DISCONTINUED OPERATIONS
Loss from Healthcare operations, net of taxes (298) (353) (282)
Loss on disposal of Healthcare operations, net of taxes (223) -- --
-------- -------- --------
Net loss from discontinued operations (521) (353) (282)
-------- -------- --------
NET INCOME $ 1,106 $ 610 $ 1,078
======== ======== ========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN MILLIONS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCUMULATED OTHER COMPREHENSIVE INCOME
------------------------------------------------------
FOREIGN NET TOTAL
CURRENCY UNREALIZED PENSION ACCUMULATED OTHER
TRANSLATION INVESTMENT LIABILITY COMPREHENSIVE RETAINED TOTAL
ADJUSTMENTS GAINS ADJUSTMENT INCOME EARNINGS EQUITY
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996 $ (24) $ 2,397 $ -- $ 2,373 $ 16,369 $ 18,742
Comprehensive income (loss):
Net income 1,078 1,078
Other comprehensive income (loss), net of tax:
Change in foreign currency translation
adjustments (32) (32) (32)
Change in net unrealized investment gains (1,261) (1,261) (1,261)
Additional pension liability adjustment (4) (4) (4)
--------
Other comprehensive income (loss) (1,297)
--------
Total comprehensive income (loss) (219)
-----------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 (56) 1,136 (4) 1,076 17,447 18,523
Comprehensive income:
Net income 610 610
Other comprehensive income (loss), net of tax:
Change in foreign currency translation
adjustments (29) (29) (29)
Change in net unrealized investment gains 616 616 616
Additional pension liability adjustment (2) (2) (2)
--------
Other comprehensive income 585
--------
Total comprehensive income 1,195
-----------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 (85) 1,752 (6) 1,661 18,057 19,718
Comprehensive income:
Net income 1,106 1,106
Other comprehensive income, net of tax:
Change in foreign currency translation
adjustments 54 54 54
Change in net unrealized investment gains (480) (480) (480)
Additional pension liability adjustment (3) (3) (3)
--------
Other comprehensive income (429)
--------
Total comprehensive income 677
-----------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ (31) $ 1,272 $ (9) $ 1,232 $ 19,163 $ 20,395
=============================================================================
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN MILLIONS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,106 $ 610 $ 1,078
Adjustments to reconcile net income to
net cash provided by operating activities:
Realized investment gains, net (2,660) (2,209) (1,138)
Policy charges and fee income (135) (258) (208)
Interest credited to policyholders' account balances 1,806 2,044 2,251
Depreciation and amortization 305 258 266
Loss (gain) on disposal of businesses 223 -- (116)
Change in:
Deferred policy acquisition costs (165) (142) (122)
Future policy benefits and other insurance liabilities 584 2,762 2,471
Securities purchased under agreements to resell (1,591) (3,314) (217)
Trading account assets (2,540) (1,825) (433)
Income taxes receivable/payable 594 (1,391) (937)
Cash collateral for borrowed securities (575) (2,631) (332)
Cash collateral for securities loaned (net) (6,985) 5,668 2,891
Broker-dealer related receivables/payables 1,495 (672) (607)
Securities sold but not yet purchased 2,122 1,633 251
Securities sold under agreements to repurchase 9,139 4,844 (490)
Other, net (5,168) 4,142 (1,334)
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES (2,445) 9,519 3,274
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale/maturity of:
Fixed maturities, available for sale 123,151 123,550 123,368
Fixed maturities, held to maturity 4,466 4,042 4,268
Equity securities, available for sale 2,792 2,572 2,162
Mortgage loans on real estate 4,839 4,299 5,731
Investment real estate 1,364 1,842 615
Other long-term investments 1,848 5,081 3,203
Disposal of businesses -- -- 52
Payments for the purchase of:
Fixed maturities, available for sale (126,742) (129,854) (125,093)
Fixed maturities, held to maturity (2,244) (2,317) (2,844)
Equity securities, available for sale (2,547) (2,461) (2,384)
Mortgage loans on real estate (4,885) (3,363) (1,906)
Investment real estate (31) (241) (142)
Other long-term investments (1,415) (4,148) (2,060)
Short-term investments (net) 2,145 (2,848) (1,915)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES 2,741 (3,846) 3,055
--------- --------- ---------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN MILLIONS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyholders' account deposits 6,955 5,020 2,676
Policyholders' account withdrawals (11,111) (9,873) (8,099)
Net increase in short-term debt 2,422 305 583
Proceeds from the issuance of long-term debt 1,940 324 93
Repayments of long-term debt (418) (464) (1,306)
-------- -------- --------
CASH FLOWS USED IN FINANCING ACTIVITIES (212) (4,688) (6,053)
-------- -------- --------
NET INCREASE IN CASH 84 985 276
CASH, BEGINNING OF YEAR 1,859 874 598
-------- -------- --------
CASH, END OF YEAR $ 1,943 $ 1,859 $ 874
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Income taxes paid $ 163 $ 968 $ 793
-------- -------- --------
Interest paid $ 864 $ 708 $ 595
-------- -------- --------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. BUSINESS
The Prudential Insurance Company of America and its subsidiaries
(collectively, "the Company") provide financial services throughout the
United States and several locations worldwide. The Company's businesses
provide a full range of insurance, investment, securities brokerage and
other financial products and services to both retail consumers and
institutions. Principal products and services provided include life
insurance, property and casualty insurance, annuities, mutual funds,
pension and retirement related investments and administration, asset
management, and securities brokerage.
DEMUTUALIZATION
On February 10, 1998, the Company's Board of Directors authorized
management to take the preliminary steps necessary to allow the Company to
demutualize and become a publicly traded stock company. On July 1, 1998,
legislation was enacted in New Jersey that would permit this conversion to
occur and that specified the process for conversion. Demutualization is a
complex process involving development of a plan of reorganization, adoption
of a plan by the Company's Board of Directors, a public hearing, voting by
qualified voters and regulatory approval. There can be no assurance that
the Company will demutualize or, if it does so, when demutualization will
occur.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of The
Prudential Insurance Company of America, a mutual life insurance company,
and its consolidated subsidiaries, and those partnerships and joint
ventures in which the Company has a controlling interest. The consolidated
financial statements have been prepared in accordance with generally
accepted accounting principles ("GAAP"). All significant intercompany
balances and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the period. Actual results could
differ from those estimates.
INVESTMENTS
FIXED MATURITIES classified as "available for sale" are carried at
estimated fair value. Fixed maturities that the Company has both the
positive intent and ability to hold to maturity are stated at amortized
cost and classified as "held to maturity." The amortized cost of fixed
maturities are written down to estimated fair value when a decline in value
is considered to be other than temporary. Unrealized gains and losses on
fixed maturities "available for sale," net of income tax, the effect on
deferred policy acquisition costs and participating annuity contracts that
would result from the realization of unrealized gains and losses, are
included in a separate component of equity, "Accumulated other
comprehensive income."
TRADING ACCOUNT ASSETS AND SECURITIES SOLD BUT NOT YET PURCHASED are
carried at estimated fair value. Realized and unrealized gains and losses
on trading account assets and securities sold but not yet purchased are
included in "Commissions and other income."
EQUITY SECURITIES, available for sale, are comprised of common and
non-redeemable preferred stock and are carried at estimated fair value. The
associated unrealized gains and losses, net of income tax, and the effects
on deferred policy acquisition costs and participating annuity contracts
that would result from the realization of unrealized gains and losses are
included in a separate component of equity, "Accumulated other
comprehensive income."
8
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MORTGAGE LOANS ON REAL ESTATE are stated primarily at unpaid principal
balances, net of unamortized discounts and allowance for losses. The
allowance for losses is based upon a loan specific review and, for
performing loans collectively evaluated, a portfolio review. The loan
specific review includes consideration of expected future cash flows
relative to outstanding balances. The portfolio review includes
consideration of the composition of the loan portfolio, current economic
conditions, past results, current trends, the estimated aggregate value of
the underlying collateral, and other relevant environmental factors.
Impaired loans are identified by management as loans in which a probability
exists that all amounts due according to the contractual terms of the loan
agreement will not be collected. Impaired loans, identified in management's
specific review of probable loan losses, are measured based on the present
value of expected future cash flows discounted at the loan's effective
interest rate, or the fair value of the collateral if the loan is
collateral dependent.
Interest received on impaired loans, including loans that were previously
modified in a troubled debt restructuring, is either applied against the
principal or reported as revenue, according to management's judgment as to
the collectibility of principal. Management discontinues the accrual of
interest on impaired loans after the loans are 90 days delinquent as to
principal or interest, or earlier when management has serious doubts about
collectibility. When a loan is recognized as impaired, any accrued but
unpaid interest previously recorded on such loan is reversed against
interest income of the current period. Generally, a loan is restored to
accrual status only after all delinquent interest and principal are brought
current and, in the case of loans where interest has been interrupted for a
substantial period, a regular payment performance has been established.
INVESTMENT REAL ESTATE to be disposed of is carried at the lower of
depreciated cost or fair value less selling costs and is not depreciated
once classified as such. Real estate which the Company has the intent to
hold for the production of income, is carried at depreciated cost less any
write-downs to fair value for impairment losses and is reviewed for
impairment whenever events or circumstances indicate the carrying value may
not be recoverable. In reviewing recoverability, an impairment loss is
recognized for an other than temporary decline in value to the extent the
reduction in carrying values of investment real estate exceeds estimated
undiscounted future cash flows. Charges relating to real estate to be
disposed of and impairments of real estate held for investment are included
in "Realized investment gains, net." Depreciation on real estate is
computed using the straight-line method over the estimated lives of the
properties.
POLICY LOANS are carried at unpaid principal balances.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER
AGREEMENTS TO REPURCHASE are treated as financing arrangements and are
carried at the amounts at which the securities will be subsequently resold
or reacquired, including accrued interest, as specified in the respective
agreements. The Company's policy is to take possession of securities
purchased under agreements to resell. The market value of securities to be
repurchased or resold is monitored, and additional collateral is requested,
where appropriate, to protect against credit exposure.
SECURITIES BORROWED AND SECURITIES LOANED are treated as financing
arrangements and are recorded at the amount of cash advanced or received.
With respect to securities loaned, the Company obtains collateral in an
amount equal to 102% and 105% of the fair value of the domestic and foreign
securities, respectively. The Company monitors the market value of
securities borrowed and loaned on a daily basis with additional collateral
obtained as necessary. Non-cash collateral received is not reflected in the
consolidated statements of financial position because the debtor typically
has the right to redeem the collateral on short notice. Substantially all
of the Company's securities borrowed contracts are with other brokers and
dealers, commercial banks and institutional clients. Substantially all of
the Company's securities loaned are with large brokerage firms.
9
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Securities repurchase and resale agreements and securities borrowed and
loaned transactions are used to generate net investment income and
facilitate trading activity. These instruments are short-term in nature
(usually 30 days or less) and are collateralized principally by U.S.
Government and mortgage-backed securities. The carrying amounts of these
instruments approximate fair value because of the relatively short period
of time between the origination of the instruments and their expected
realization.
OTHER LONG-TERM INVESTMENTS primarily represent the Company's investments
in joint ventures and partnerships in which the Company does not have
control and derivatives held for purposes other than trading. Joint venture
and partnership investments are recorded using the equity method of
accounting, reduced for other than temporary declines in value.
SHORT-TERM INVESTMENTS, including highly liquid debt instruments purchased
with an original maturity of twelve months or less, are carried at
amortized cost, which approximates fair value.
REALIZED INVESTMENT GAINS, NET are computed using the specific
identification method. Costs of fixed maturities and equity securities are
adjusted for impairments considered to be other than temporary. Allowances
for losses on mortgage loans on real estate are netted against asset
categories to which they apply and provisions for losses on investments are
included in "Realized investment gains, net." Decreases in the lower of
depreciated cost or fair value less selling costs of investment real estate
held for sale are recorded in "Realized investment gains, net."
CASH
Cash includes cash on hand, amounts due from banks, and money market
instruments.
DEFERRED POLICY ACQUISITION COSTS
The costs which vary with and that are related primarily to the production
of new insurance business are deferred to the extent such costs are deemed
recoverable from future profits. Such costs include certain commissions,
costs of policy issuance and underwriting, and certain variable field
office expenses. Deferred policy acquisition costs are subject to
recoverability testing at the time of policy issue and loss recognition
testing at the end of each accounting period. Deferred policy acquisition
costs, for certain products, are adjusted for the impact of unrealized
gains or losses on investments as if these gains or losses had been
realized, with corresponding credits or charges included in "Accumulated
other comprehensive income."
For participating life insurance, deferred policy acquisition costs are
amortized over the expected life of the contracts (up to 45 years) in
proportion to estimated gross margins based on historical and anticipated
future experience, which is updated periodically. The effect of changes in
estimated gross margins is reflected in earnings in the period they are
revised. Policy acquisition costs related to interest-sensitive products
and certain investment-type products are deferred and amortized over the
expected life of the contracts (periods ranging from 15 to 30 years) in
proportion to estimated gross profits arising principally from investment
results, mortality and expense margins and surrender charges based on
historical and anticipated future experience, updated periodically. The
effect of revisions to estimated gross profits on unamortized deferred
acquisition costs is reflected in earnings in the period such estimated
gross profits are revised. The average rate of assumed investment yield in
estimating expected gross margins was 9.97%, 9.39%, and 8.39% for 1998,
1997 and 1996, respectively. Deferred policy acquisition costs related to
non-participatory term insurance are amortized over the expected life of
the contracts in proportion to the premium income.
For property and casualty contracts, deferred policy acquisition costs are
amortized over the period in which related premiums are earned. Future
investment income is considered in determining the recoverability of
deferred policy acquisition costs.
10
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
For disability insurance, group life insurance and most group annuities,
acquisition costs are expensed as incurred.
POLICYHOLDERS' DIVIDENDS
The amount of the dividends to be paid to policyholders is determined
annually by the Company's Board of Directors. The aggregate amount of
policyholders' dividends is related to actual interest, mortality,
morbidity, persistency and expense experience for the year and judgment as
to the appropriate level of statutory surplus to be retained by the
Company.
SEPARATE ACCOUNT ASSETS AND LIABILITIES
Separate Account assets and liabilities are reported at estimated fair
value and represent segregated funds which are invested for certain
policyholders, pension fund and other customers. The assets consist of
common stocks, fixed maturities, real estate related securities, real
estate mortgage loans and short term investments. The assets of each
account are legally segregated and are not subject to claims that arise out
of any other business of the Company. Investment risks associated with
market value changes are generally borne by the customers, except to the
extent of minimum guarantees made by the Company with respect to certain
accounts. The investment income and gains or losses for separate accounts
generally accrue to the policyholders and are not included in the
Consolidated Statements of Operations. Mortality, policy administration and
surrender charges on the accounts are included in "Policy charges and fee
income."
OTHER ASSETS AND OTHER LIABILITIES
Other assets consist primarily of prepaid benefit costs, reinsurance
recoverables, certain restricted assets, trade receivables and property and
equipment. Property and equipment are stated at cost less accumulated
depreciation. Depreciation is determined using the straight-line method
over the estimated useful lives of the related assets which generally range
from 3 to 40 years. Other liabilities consist primarily of trade payables
and reserves for sales practice remediation costs.
INSURANCE REVENUE AND EXPENSE RECOGNITION
Premiums from participating insurance policies are recognized when due.
Benefits are recorded as an expense when they are incurred. A liability for
future policy benefits is recorded using the net level premium method.
Premiums from non-participating group annuities with life contingencies are
recognized when due. For single premium immediate annuities and structured
settlements, premiums are recognized when due with any excess profit
deferred and recognized in a constant relationship to insurance in-force
or, for annuities, the amount of expected future benefit payments.
Amounts received as payment for interest sensitive investment contracts,
deferred annuities and participating group annuities are reported as
deposits to "Policyholders' account balances." Revenues from these
contracts are reflected in "Policy charges and fee income" and consist
primarily of fees assessed during the period against the policyholders'
account balances for mortality charges, policy administration charges,
surrender charges and interest earned from the investment of these account
balances. Benefits and expenses for these products include claims in excess
of related account balances, expenses of contract administration, interest
credited and amortization of deferred policy acquisition costs.
For disability insurance, group life insurance, and property and casualty
insurance, premiums are recognized over the period to which the premiums
relate in proportion to the amount of insurance protection provided. Claim
and claim adjustment expenses are recognized when incurred.
11
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Premiums, benefits and expenses are stated net of reinsurance ceded to
other companies. Estimated reinsurance receivables and the cost of
reinsurance are recognized over the life of the reinsured policies using
assumptions consistent with those used to account for the underlying
policies.
FOREIGN CURRENCY TRANSLATION ADJUSTMENTS
Assets and liabilities of foreign operations and subsidiaries reported in
other than U.S. dollars are translated at the exchange rate in effect at
the end of the period. Revenues, benefits and other expenses are translated
at the average rate prevailing during the period. The effects of
translating the Statements of Financial Position of non-U.S. entities with
functional currencies other than the U.S. dollar are recorded, net of
related hedge gains and losses and income taxes, as "Other comprehensive
income," a separate component of equity.
COMMISSIONS AND OTHER INCOME
Commissions and other income principally includes securities and
commodities commission revenues, asset management fees, investment banking
revenue and realized and unrealized gains from trading activities of the
Company's broker-dealer subsidiary.
DERIVATIVE FINANCIAL INSTRUMENTS
Derivatives are financial instruments whose values are derived from
interest rates, foreign exchange rates, various financial indices, or the
value of securities or commodities. Derivative financial instruments can be
exchange-traded or contracted in the over-the-counter market and those used
by the Company include swaps, futures, forwards and options contracts. The
Company uses derivative financial instruments to hedge market risk from
changes in interest rates or foreign currency exchange rates, and to alter
interest rate or currency exposures arising from mismatches between assets
and liabilities. Additionally, derivatives are used in the broker-dealer
business and in a limited-purpose subsidiary for trading purposes.
To qualify as a hedge, derivatives must be designated as hedges for
existing assets, liabilities, firm commitments, or anticipated transactions
which are identified and probable to occur, and effective in reducing the
market risk to which the Company is exposed. The effectiveness of the
derivatives are evaluated at the inception of the hedge and throughout the
hedge period.
DERIVATIVES HELD FOR TRADING PURPOSES are used in the Company's securities
broker-dealer business and in a limited-purpose subsidiary to meet the
needs of its customers by structuring transactions that allow customers to
manage their exposure to interest rates, foreign exchange rates, indices or
prices of securities and commodities. Trading derivative positions are
valued daily, generally by obtaining quoted market prices or through the
use of pricing models. Values are affected by changes in interest rates,
currency exchange rates, credit spreads, market volatility and liquidity.
The Company monitors these exposures through the use of various analytical
techniques.
Derivatives held for trading are recorded at fair value in "Trading account
assets," "Other liabilities" or "Receivables from/Payables to broker-dealer
clients" in the Consolidated Statements of Financial Position, and realized
and unrealized changes in fair value are included in "Commissions and other
income" of the Consolidated Statements of Operations in the periods in
which the changes occur. Cash flows from trading derivatives are reported
in the operating activities section of the Consolidated Statements of Cash
Flows.
DERIVATIVES HELD FOR PURPOSES OTHER THAN TRADING are primarily used to
hedge or reduce exposure to interest rate and foreign currency risks
associated with assets held or expected to be purchased or sold, and
liabilities incurred or expected to be incurred. Additionally, other than
trading derivatives are used to change the characteristics of the Company's
asset/liability mix consistent with the Company's risk management
activities.
12
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
See Note 14 for a discussion of the accounting treatment of derivatives
that qualify as hedges. If the Company's use of other than trading
derivatives does not meet the criteria to apply hedge accounting, the
derivatives are recorded at fair value in "Other long-term investments" or
"Other liabilities" in the Consolidated Statements of Financial Position,
and changes in their fair value are recognized in earnings in "Realized
investment gains, net" without considering changes in the hedged assets or
liabilities. Cash flows from other than trading derivative assets and
liabilities are reported in the investing activities section in the
Consolidated Statements of Cash Flows.
INCOME TAXES
The Company and its domestic subsidiaries file a consolidated federal
income tax return. The Internal Revenue Code (the "Code") limits the amount
of non-life insurance losses that may offset life insurance company taxable
income. The Code also imposes an "equity tax" on mutual life insurance
companies which, in effect, imputes an additional tax to the Company based
on a formula that calculates the difference between stock and mutual life
insurance companies' earnings. Income taxes include an estimate for changes
in the total equity tax to be paid for current and prior years.
Subsidiaries operating outside the United States are taxed under applicable
foreign statutes.
Deferred income taxes are generally recognized, based on enacted rates,
when assets and liabilities have different values for financial statement
and tax reporting purposes. A valuation allowance is recorded to reduce a
deferred tax asset to that portion that is expected to be realized.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued the
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" ("SFAS 125"). The statement provides accounting and reporting
standards for transfers and servicing of financial assets and
extinguishments of liabilities and provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers
that are secured borrowings. SFAS 125 became effective January 1, 1997 and
was applied prospectively. Subsequent to June 1996, FASB issued SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of SFAS 125"
("SFAS 127"). SFAS 127 delayed the implementation of SFAS 125 for one year
for certain provisions, including repurchase agreements, dollar rolls,
securities lending and similar transactions. The Company adopted the
delayed provisions of SFAS 125 in 1998. The adoption of SFAS 125 did not
have a material impact on the Company's results of operations or financial
position.
During 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income," which was issued by the FASB in June 1997. This statement defines
comprehensive income and establishes standards for reporting and displaying
comprehensive income and its components in financial statements. The
statement requires that the Company classify items of other comprehensive
income by their nature and display the accumulated balance of other
comprehensive income separately from retained earnings in the equity
section of the Statements of Financial Position. Application of this
statement did not change recognition or measurement of net income and,
therefore, did not affect the Company's financial position or results of
operations.
During 1998, the Company adopted SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which was issued by the
FASB in February 1998. This statement standardizes the disclosure
requirements for pensions and other postretirement benefits, requires
additional information on changes in the benefit obligations and fair
values of plan assets and eliminates certain disclosures. This statement is
limited to changes in reporting and presentation and does not change
recognition or measurement of pension or other postretirement benefit
plans. Therefore, its adoption did not affect the Company's financial
position or results of operations.
13
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
On January 1, 1998, the Company adopted the American Institute of Certified
Public Accountants ("AICPA") Statement of Position 97-3, "Accounting by
Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP
97-3"). This statement provides guidance for determining when an insurance
company or other enterprise should recognize a liability for guaranty-fund
assessments as well as guidance for measuring the liability. The adoption
of SOP 97-3 did not have a material effect on the Company's financial
condition or results of operations. In June 1998, the FASB issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" which
requires that companies recognize all derivatives as either assets or
liabilities in the balance sheet and measure those instruments at fair
value. SFAS No. 133 provides, if certain conditions are met, that a
derivative may be specifically designated as (1) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment (fair value hedge), (2) a hedge of the
exposure to variable cash flows of a forecasted transaction (cash flow
hedge), or (3) a hedge of the foreign currency exposure of a net investment
in a foreign operation, an unrecognized firm commitment, an
available-for-sale security or a foreign-currency-denominated forecasted
transaction (foreign currency hedge).
SFAS No. 133 does not apply to most traditional insurance contracts.
However, certain hybrid contracts that contain features which can affect
settlement amounts similarly to derivatives may require separate accounting
for the "host contract" and the underlying "embedded derivative"
provisions. The latter provisions would be accounted for as derivatives as
specified by the statement.
Under SFAS No. 133, the accounting for changes in fair value of a
derivative depends on its intended use and designation. For a fair value
hedge, the gain or loss is recognized in earnings in the period of change
together with the offsetting loss or gain on the hedged item. For a cash
flow hedge, the effective portion of the derivative's gain or loss is
initially reported as a component of other comprehensive income and
subsequently reclassified into earnings when the forecasted transaction
affects earnings. For a foreign currency hedge, the gain or loss is
reported in other comprehensive income as part of the foreign currency
translation adjustment. For all other derivatives not designated as hedging
instruments, the gain or loss is recognized in earnings in the period of
change. The Company is required to adopt this Statement no later than
January 1, 2000 and is currently assessing the effect of the new standard.
In October 1998, the AICPA issued Statement of Position 98-7, "Deposit
Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not
Transfer Insurance Risk," ("SOP 98-7"). This statement provides guidance on
how to account for insurance and reinsurance contracts that do not transfer
insurance risk. SOP 98-7 is effective for fiscal years beginning after June
15, 1999. The adoption of this statement is not expected to have a material
effect on the Company's financial position or results of operations.
RECLASSIFICATIONS
Certain amounts in prior years have been reclassified to conform to current
year presentation.
14
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
3. DISCONTINUED OPERATIONS
In December 1998, the Company entered into a definitive agreement to sell
its HealthCare business to Aetna Inc. ("Aetna"). Included in this
transaction are the Company's managed medical care, point of service,
preferred provider organization and indemnity health lines, dental
business, as well as the Company's Administrative Services Only ("ASO")
businesses. The transaction was approved by the boards of directors of both
companies and is expected to be completed in the second quarter of 1999,
subject to review by federal antitrust authorities and approval by state
regulators, and other customary closing conditions. Proceeds from the sale
will consist of $500 million of cash and $500 million of Aetna three year
senior notes.
Loss from operations of discontinued businesses for 1998 includes results
through December 31, 1998 (the measurement date). The Statements of
Operations for 1997 and 1996 have been restated to conform with the 1998
presentation. Amounts within the footnotes have been adjusted, where noted,
to eliminate the impact of discontinued operations and to be consistent
with the presentation in the Consolidated Statements of Operations. The
following table presents the results of operations and the loss on the
disposal of the Company's HealthCare business, determined as of the
measurement date, which are included in "Discontinued Operations" in the
Consolidated Statements of Operations. Amounts for 1997 and 1996 include
revenues and expenses relating to a contract with the American Association
of Retired Persons for healthcare and similar coverages which was
terminated effective December 31, 1997.
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
(In Millions)
<S> <C> <C> <C>
Revenues $ 7,461 $ 10,305 $ 9,187
Policyholder benefits (6,064) (8,484) (7,711)
General and administrative expenses (1,822) (2,364) (1,921)
--------- --------- ---------
Loss before income taxes (425) (543) (445)
Income tax benefit 127 190 163
--------- --------- ---------
Loss from operations (298) (353) (282)
Loss on disposal, net of tax benefit of $131 (223) - -
--------- --------- ---------
Loss from discontinued operations, net of taxes $ (521) $ (353) $ (282)
========= ========= =========
</TABLE>
The loss on disposal includes anticipated operating losses to be incurred
by the HealthCare business subsequent to the measurement date through the
expected date of the sale, as well as estimates of other costs the Company
will incur in connection with the disposition of the HealthCare business.
Actual amounts may differ from these estimates. These include costs
attributable to facilities closure and systems terminations, severance,
payments to Aetna related to the ASO business, and estimated payments in
connection with an agreement covering the fully insured medical and dental
business. The latter agreement provides for payments either to or from
Aetna in the event that medical loss ratios (i.e., incurred medical expense
divided by earned premiums) for covered businesses are either less
favorable or more favorable than levels specified in the agreement for the
years 1999 and 2000. The loss on disposition was reduced by the estimated
impact of expected modifications of certain pension and other
postretirement benefit plans in which employees of the HealthCare business
participate. This amount includes curtailment gains and the cost of
termination benefits. (See Note 9.)
15
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
3. DISCONTINUED OPERATIONS (CONTINUED)
The following table presents the assets and liabilities pertaining to the
Company's HealthCare business at December 31, 1998 which are included in
the Company's Consolidated Statements of Financial Position.
(In Millions)
Cash and investments $ 1,652
Other assets 1,030
-------
Total assets 2,682
Future policy benefits 1,241
Other liabilities 1,105
-------
Total liabilities 2,346
-------
Net assets $ 336
=======
4. INVESTMENTS
FIXED MATURITIES AND EQUITY SECURITIES
The following tables provide additional information relating to fixed
maturities and equity securities (excluding trading account assets) as of
December 31:
<TABLE>
<CAPTION>
1998
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
(In Millions)
<S> <C> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 5,761 $ 580 $ 9 $ 6,332
Obligations of U.S. states and
their political subdivisions 2,672 204 1 2,875
Foreign government bonds 3,156 253 52 3,357
Corporate securities 57,373 2,545 553 59,365
Mortgage-backed securities 7,935 208 14 8,129
Other fixed maturities 100 - - 100
-----------------------------------------------------------
Total fixed maturities available for sale $ 76,997 $ 3,790 $ 629 $ 80,158
===========================================================
EQUITY SECURITIES AVAILABLE FOR SALE $ 2,583 $ 472 $ 296 $ 2,759
===========================================================
</TABLE>
16
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
1998
------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
FIXED MATURITIES HELD TO MATURITY (In Millions)
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 5 $ - $ - $ 5
Obligations of U.S. states and
their political subdivisions 62 2 1 63
Foreign government bonds 31 4 - 35
Corporate securities 16,699 1,096 49 17,746
Mortgage-backed securities 1 - - 1
Other fixed maturities 50 6 - 56
------------------------------------------------------------
Total fixed maturities held to maturity $ 16,848 $ 1,108 $ 50 $ 17,906
============================================================
<CAPTION>
1997
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE (In Millions)
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 9,071 $ 671 $ - $ 9,742
Obligations of U.S. states and
their political subdivisions 1,529 152 - 1,681
Foreign government bonds 3,177 218 17 3,378
Corporate securities 50,043 2,611 144 52,510
Mortgage-backed securities 7,576 288 5 7,859
Other fixed maturities 100 - - 100
-----------------------------------------------------------
Total fixed maturities available for sale $ 71,496 $ 3,940 $ 166 $ 75,270
===========================================================
EQUITY SECURITIES AVAILABLE FOR SALE $ 2,376 $ 680 $ 246 $ 2,810
===========================================================
</TABLE>
17
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
1997
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ---------- ----------- ----------
(In Millions)
<S> <C> <C> <C> <C>
FIXED MATURITIES HELD TO MATURITY
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 88 $ - $ - $ 88
Obligations of U.S. states and
their political subdivisions 152 4 1 155
Foreign government bonds 33 5 - 38
Corporate securities 18,282 1,212 34 19,460
Mortgage-backed securities 1 - - 1
Other fixed maturities 144 8 - 152
------------------------------------------------------------
Total fixed maturities held to maturity $ 18,700 $ 1,229 $ 35 $ 19,894
============================================================
</TABLE>
18
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturities by
contractual maturities at December 31, 1998, is shown below:
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
---------------------------- -----------------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------ -------------- ----------- ----------
(In Millions) (In Millions)
<S> <C> <C> <C> <C>
Due in one year or less $ 2,638 $ 2,644 $ 730 $ 736
Due after one year through five years 17,551 17,874 4,326 4,465
Due after five years through ten years 19,523 19,976 6,783 7,162
Due after ten years 29,350 31,535 5,008 5,542
Mortgage-backed securities 7,935 8,129 1 1
--------- ---------- -------- --------
Total $ 76,997 $ 80,158 $ 16,848 $ 17,906
========= ========== ======== ========
</TABLE>
Actual maturities may differ from contractual maturities because issuers
may have the right to call or prepay obligations.
Proceeds from the repayment of held to maturity fixed maturities during
1998, 1997 and 1996 were $4,466 million, $4,042 million and $4,268 million,
respectively. Gross gains of $135 million, $62 million and $78 million, and
gross losses of $2 million, $1 million and $7 million, were realized on
prepayment of held to maturity fixed maturities during 1998, 1997 and 1996,
respectively.
Proceeds from the sale of available for sale fixed maturities during 1998,
1997 and 1996 were $119,096 million, $120,604 million and $121,910 million,
respectively. Proceeds from the maturity of available for sale fixed
maturities during 1998, 1997 and 1996 were $ 4,055 million, $2,946 million
and $1,458 million, respectively. Gross gains of $1,765 million, $1,310
million and $1,562 million and gross losses of $443 million, $639 million
and $1,026 million were realized on sales and prepayments of available for
sale fixed maturities during 1998, 1997 and 1996, respectively.
Writedowns for impairments of fixed maturities which were deemed to be
other than temporary were $96 million, $13 million and $54 million for the
years 1998, 1997 and 1996, respectively.
During the years ended December 31, 1998 and December 31, 1997, certain
securities classified as held to maturity were transferred to the available
for sale portfolio. These actions were taken as a result of a significant
deterioration in credit worthiness. The aggregate amortized cost of the
securities transferred was $73 million and $27 million, respectively with
gross unrealized investment losses of $.4 million and gross unrealized
investment gains of $.6 million included during the years ended December
31, 1998 and 1997, respectively, in "Accumulated other comprehensive
income" at the time of the transfer.
19
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
MORTGAGE LOANS ON REAL ESTATE
The Company's mortgage loans were collateralized by the following property
types at December 31:
AMOUNT PERCENTAGE AMOUNT PERCENTAGE
(IN MILLIONS) OF TOTAL (IN MILLIONS) OF TOTAL
------------- ---------- ------------- ----------
1998 1997
------------------------ -------------------------
Office buildings $ 4,267 25.2% $ 4,692 28.5%
Retail stores 3,021 17.9% 3,078 18.7%
Residential properties 716 4.2% 891 5.4%
Apartment complexes 4,362 25.8% 3,551 21.6%
Industrial buildings 1,989 11.8% 1,958 11.9%
Agricultural properties 1,936 11.4% 1,666 10.1%
Other 631 3.7% 618 3.8%
-------- ----- -------- -----
Subtotal 16,922 100.0% 16,454 100.0%
===== =====
Allowance for losses (427) (450)
-------- --------
Net carrying value $ 16,495 $ 16,004
======== ========
The mortgage loans are geographically dispersed throughout the United
States and Canada with the largest concentrations in California (23.8%)
and New York (9.5%) at December 31, 1998. Included in the above balances
are mortgage loans receivable from affiliated joint ventures of $87 million
and $225 million at December 31, 1998 and 1997, respectively.
Activity in the allowance for losses for all mortgage loans, for the years
ended December 31, is summarized as follows:
1998 1997 1996
----- ----- -----
(In Millions)
Allowance for losses, beginning of year $ 450 $ 515 $ 862
Additions charged to operations - - -
Release of allowance for losses - (41) (247)
Charge-offs, net of recoveries (23) (24) (100)
----- ----- -----
Allowance for losses, end of year $ 427 $ 450 $ 515
===== ===== =====
The $41 million and $247 million reductions of the mortgage loan allowance
for losses in 1997 and 1996, respectively, are primarily attributable to
the improved economic climate, changes in the nature and mix of borrowers
and underlying collateral and a significant decrease in impaired loans.
20
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
Impaired mortgage loans identified in management's specific review of
probable loan losses and related allowance for losses at December 31, are
as follows:
1998 1997
------- -------
(In Millions)
Impaired mortgage loans with allowance for losses $ 149 $ 330
Impaired mortgage loans with no allowance for losses 924 1,303
Allowance for losses (45) (97)
------- -------
Net carrying value of impaired mortgage loans $ 1,028 $ 1,536
======= =======
Impaired mortgage loans with no provision for losses are loans where the
fair value of the collateral or the net present value of the expected
future cash flows related to the loan equals or exceeds the recorded
investment. The average recorded investment in impaired loans before
allowance for losses was $1,329 million, $2,102 million and $2,842 million
during 1998, 1997 and 1996, respectively. Net investment income recognized
on these loans totaled $94 million, $140 million and $265 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
INVESTMENT REAL ESTATE
The Company's "Investment real estate" of $801 million and $1,519 million
at December 31, 1998 and 1997, respectively, is held through direct
ownership. Of the Company's real estate, $675 million and $1,490 million
consists of commercial and agricultural assets held for disposal at
December 31, 1998 and 1997, respectively. Impairment losses aggregated $8
million, $40 million and $38 million for the years ended December 31, 1998,
1997 and 1996, respectively, and are included in "Realized investment
gains, net."
RESTRICTED ASSETS AND SPECIAL DEPOSITS
Assets of $3,135 million and $2,783 million at December 31, 1998 and 1997,
respectively, were on deposit with governmental authorities or trustees as
required by certain insurance laws. Additionally, assets valued at $3,727
million and $2,352 million at December 31, 1998 and 1997, respectively,
were held in voluntary trusts. Of this amount, $3,131 million and $1,801
million at December 31, 1998 and 1997, respectively, related to the
multi-state policyholder settlement as described in Note 16. The remainder
relates to trusts established to fund guaranteed dividends to certain
policyholders. The terms of these trusts provide that the assets are to be
used for payment of the designated settlement and dividend benefits, as the
case may be. Assets valued at $403 million and $632 million at December 31,
1998 and 1997, respectively, were maintained as compensating balances,
which do not legally restrict the use of the funds, or pledged as
collateral for bank loans and other financing agreements. Restricted cash
and securities of $2,366 million and $1,835 million at December 31, 1998
and 1997, respectively, were included in the consolidated financial
statements in "Other assets." The restricted cash represents funds
deposited by clients and funds accruing to clients as a result of trades or
contracts.
OTHER LONG-TERM INVESTMENTS
The Company's "Other long-term investments" of $2,658 million and $2,489
million as of December 31, 1998 and 1997, respectively, are comprised of
$1,007 million and $1,498 million in real estate related interests and
$1,651 million and $991 million of non-real estate related interests. The
Company's share of net income from such entities was $285 million, $411
million and $245 million for 1998, 1997 and 1996, respectively, and is
reported in "Net investment income."
21
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
INVESTMENT INCOME AND INVESTMENT GAINS AND LOSSES
NET INVESTMENT INCOME arose from the following sources for the years ended
December 31:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(In Millions)
<S> <C> <C> <C>
Fixed maturities - available for sale $ 5,366 $ 5,074 $ 4,871
Fixed maturities - held to maturity 1,406 1,622 1,793
Trading account assets 677 504 444
Equity securities - available for sale 54 52 81
Mortgage loans on real estate 1,525 1,555 1,690
Investment real estate 230 565 685
Policy loans 410 396 384
Securities purchased under agreements to resell 18 15 11
Receivables from broker-dealer clients 836 706 579
Short-term investments 725 697 702
Other investment income 415 520 559
-------- -------- --------
Gross investment income 11,662 11,706 11,799
Less investment expenses (2,035) (2,038) (2,130)
-------- -------- --------
Subtotal 9,627 9,668 9,669
Less amount relating to discontinued operations (107) (212) (208)
-------- -------- --------
Net investment income $ 9,520 $ 9,456 $ 9,461
======== ======== ========
</TABLE>
REALIZED INVESTMENT GAINS, NET, for the years ended December 31, were from
the following sources:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(In Millions)
<S> <C> <C> <C>
Fixed maturities $ 1,381 $ 684 $ 513
Mortgage loans on real estate 22 68 248
Investment real estate 642 700 76
Equity securities - available for sale 427 363 267
Other 188 394 34
-------- -------- --------
Subtotal 2,660 2,209 1,138
Less amounts related to discontinued operations (30) (41) (10)
-------- -------- --------
Realized investment gains, net $ 2,630 $ 2,168 $ 1,128
======== ======== ========
</TABLE>
Based on the carrying value, assets categorized as "non-income producing"
for the year ended December 31, 1998 included in fixed maturities available
for sale, mortgage loans on real estate and other long term investments
totaled $1 million, $23 million and $13 million, respectively.
22
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. INVESTMENTS (CONTINUED)
NET UNREALIZED INVESTMENT GAINS
Net unrealized investment gains on securities available for sale are
included in the Consolidated Statements of Financial Position as a
component of "Accumulated other comprehensive income." Changes in these
amounts include reclassification adjustments to avoid double-counting in
"Comprehensive income," items that are included as part of "Net income" for
a period that also had been part of "Other comprehensive income" in earlier
periods. The amounts for the years ended December 31, are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In Millions)
<S> <C> <C> <C>
Net unrealized investment gains, beginning of year $ 1,752 $ 1,136 $ 2,397
Changes in net unrealized investment gains attributable to:
Investments:
Net unrealized investment gains (losses) on investments arising
during the period 522 1,706 (1,281)
Reclassification adjustment for gains included in net income (1,087) (631) (471)
------- ------- -------
Change in net unrealized investment gains, net of adjustments (565) 1,075 (1,752)
Impact of net unrealized investment gains on:
Future policy benefits 23 (360) 318
Deferred policy acquisition costs 62 (99) 173
------- ------- -------
Change in net unrealized investment gains (480) 616 (1,261)
------- ------- -------
Net unrealized investment gains, end of year $ 1,272 $ 1,752 $ 1,136
======= ======= =======
</TABLE>
Unrealized gains (losses) on investments arising during the periods
reported in the above table are net of income tax expense (benefit) of $282
million, $961 million and $(647) million for the years ended December 31,
1998, 1997 and 1996, respectively.
Reclassification adjustments reported in the above table for the years
ended December 31, 1998, 1997 and 1996 are net of income tax expense of
$588 million, $355 million and $238 million, respectively.
The future policy benefits reported in the above table are net of income
tax expense (benefit) of $15 million, $(203) million and $161 million for
the years ended December 31, 1998, 1997 and 1996, respectively.
Deferred policy acquisition costs in the above tables for the years ended
December 31, 1998, 1997 and 1996 are net of income tax expense (benefit) of
$36 million, $(55) million and $88 million, respectively.
23
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. DEFERRED POLICY ACQUISITION COSTS
The balances of and changes in deferred policy acquisition costs as of and
for the years ended December 31, are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In Millions)
<S> <C> <C> <C>
Balance, beginning of year $ 6,083 $ 6,095 $ 5,892
Capitalization of commissions, sales and issue expenses 1,313 1,409 1,260
Amortization (1,139) (1,176) (1,261)
Change in unrealized investment gains 77 (154) 261
Foreign currency translation 128 (91) (57)
------- ------- -------
Balance, end of year $ 6,462 $ 6,083 $ 6,095
======= ======= =======
</TABLE>
6. POLICYHOLDERS' LIABILITIES
FUTURE POLICY BENEFITS at December 31, are as follows:
1998 1997
------- -------
(In Millions)
Life insurance $48,927 $46,765
Annuities 15,360 15,469
Other contract liabilities 4,842 5,133
------- -------
Future policy benefits $69,129 $67,367
======= =======
Life insurance liabilities include reserves for death and endowment policy
benefits, terminal dividends, premium deficiency reserves, and certain
health benefits. Annuity liabilities include reserves for immediate
annuities and non-participating group annuities. Other contract liabilities
primarily consist of unearned premium and benefit reserves for group health
products.
24
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
6. POLICYHOLDERS' LIABILITIES (CONTINUED)
The following table highlights the key assumptions generally utilized in
calculating these reserves:
<TABLE>
<CAPTION>
PRODUCT MORTALITY INTEREST RATE ESTIMATION METHOD
- --------------------------- ------------------------- ------------------------- ------------------------
<S> <C> <C> <C>
Life insurance Generally rates 2.5% to 7.5% Net level premium
guaranteed in calculating based on non-forfeiture
cash surrender values interest rate
Individual immediate 1983 Individual 3.5% to 11.25% Present value of
annuities Annuity Mortality expected future payments
Table with certain based on historical
modifications experience
Group annuities in 1950 Group 3.75% to 17.35% Present value of
payout status Annuity Mortality expected future
Table with certain payments
modifications based on historical
experience
Other contract liabilities - 5.3% to 7.0% Present value of
expected future
payments
based on historical
experience
</TABLE>
For the above categories, premium deficiency reserves are established, if
necessary, when the liability for future policy benefits plus the present
value of expected future gross premiums are insufficient to provide for
expected future policy benefits and expenses and to recover any unamortized
acquisition costs. A premium deficiency reserve has been recorded for the
group single premium annuity business, which consists of limited-payment,
long duration, traditional and non-participating annuities. A liability of
$1,780 million and $1,645 million is included in "Future policy benefits"
with respect to this deficiency for the years ended December 31, 1998 and
1997, respectively.
POLICYHOLDERS' ACCOUNT BALANCES at December 31, are as follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
(In Millions)
<S> <C> <C>
Individual annuities $ 4,997 $ 5,695
Group annuities and guaranteed investment contracts 16,770 19,053
Interest-sensitive life contracts 3,566 3,258
Dividend accumulations and other 5,641 5,240
------- --------
Policyholders' account balances $30,974 $ 33,246
======= ========
</TABLE>
Policyholders' account balances for interest-sensitive life and
investment-type contracts represent an accumulation of gross premium
payments plus credited interest less withdrawals, expenses and mortality
charges.
25
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
6. POLICYHOLDERS' LIABILITIES (Continued)
Certain contract provisions that determine the policyholder account
balances are as follows:
<TABLE>
<CAPTION>
WITHDRAWAL/
PRODUCT INTEREST RATE SURRENDER CHARGES
--------------------------------- ------------- -----------------------------------
<S> <C> <C>
Individual annuities 3.0% to 6.6% 0% to 8% for up to 8 years
Group annuities 5.0% to 13.4% Contractually limited or subject
to market value adjustment
Guaranteed investment contracts 3.9% to 15.4% Subject to market value withdrawal
payout status provisions for any funds withdrawn
other than for benefit responsive
and contractual payments
Interest-sensitive life contracts 4.0% to 6.5% Various up to 10 years
Dividend accumulations and other 3.0% to 4.5% --
</TABLE>
26
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
6. POLICYHOLDERS' LIABILITIES (Continued)
Unpaid Claims and Claim Adjustment Expenses. The following table provides
a reconciliation of the activity in the liability for unpaid claims and
claim adjustment expenses for property and casualty and accident and
health insurance at December 31:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------- -------------------------- -----------------------
ACCIDENT PROPERTY ACCIDENT PROPERTY ACCIDENT PROPERTY
AND HEALTH AND CASUALTY AND HEALTH AND CASUALTY AND HEALTH AND CASUALTY
---------- ------------ ---------- ------------ ---------- -------------
(In Millions)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1 $ 1,908 $ 2,956 $ 1,990 $ 3,076 $ 2,033 $ 3,053
Less reinsurance recoverables 810 535 10 553 15 557
------- ------- ------- ------- ------- -------
Net balance at January 1 1,098 2,421 1,980 2,523 2,018 2,496
------- ------- ------- ------- ------- -------
Incurred related to:
Current year 6,127 1,354 8,348 1,525 8,391 1,760
Prior years 7 (194) 102 (91) (66) (25)
------- ------- ------- ------- ------- -------
Total incurred 6,134 1,160 8,450 1,434 8,325 1,735
------- ------- ------- ------- ------- -------
Paid related to:
Current year 5,289 717 6,676 739 6,589 908
Prior years 851 681 1,854 797 1,774 800
------- ------- ------- ------- ------- -------
Total paid 6,140 1,398 8,530 1,536 8,363 1,708
------- ------- ------- ------- ------- -------
Net balance at December 31 1,092 2,183 1,900 2,421 1,980 2,523
Plus reinsurance recoverables 52 533 8 535 10 553
------- ------- ------- ------- ------- -------
Balance at December 31 $ 1,144 $ 2,716 $ 1,908 $ 2,956 $ 1,990 $ 3,076
======= ======= ======= ======= ======= =======
</TABLE>
The Accident and Health balance at December 31 includes amounts
attributable to the Company's discontinued HealthCare business: 1998 -
$1,082; 1997 - $1,757 and 1996 - $1,750.
In 1998 and 1997, the changes in provision for claims and claim adjustment
expenses for property and casualty related to prior years are primarily
driven by lower than anticipated losses for the Voluntary Auto line of
business.
The changes in provision for claims and claim adjustment expense for
accident and health related to prior years are primarily due to such
factors as changes in claim cost trends and an accelerated decline in the
indemnity health business.
The unpaid claims and claim adjustment expenses presented above consist of
unpaid claim liabilities which include estimates for liabilities
associated with reported claims and for incurred but not reported claims
based, in part, on the Company's experience. Changes in the estimated cost
to settle unpaid claims are charged or credited to the Consolidated
Statement of Operations periodically as the estimates are revised.
Accident and health unpaid claims liabilities for 1998, 1997 and 1996
included above are discounted using interest rates ranging from 3.0%
to 6.0%.
27
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
7. REINSURANCE
The Company participates in reinsurance in order to provide greater
diversification of business, provide additional capacity for future growth
and limit the maximum net loss potential arising from large risks. Life
reinsurance is accomplished through various plans of reinsurance,
primarily yearly renewable term and coinsurance. Property-casualty
reinsurance is placed on both a pro-rata and excess of loss basis.
Reinsurance ceded arrangements do not discharge the Company or the
insurance subsidiaries as the primary insurer. Ceded balances would
represent a liability to the Company in the event the reinsurers were
unable to meet their obligations to the Company under the terms of the
reinsurance agreements. The Company periodically reviews the financial
condition of its reinsurers and amounts recoverable therefrom, recording
an allowance when necessary for uncollectible reinsurance.
Reinsurance amounts included in the Consolidated Statements of Operations,
excluding HealthCare, for the years ended December 31, were as follows:
1998 1997 1996
------- ------ -------
(In Millions)
Direct Premiums $9,615 $9,679 $10,690
Reinsurance Assumed 65 42 13
Reinsurance Ceded (656) (716) (704)
------ ------ -------
Premiums $9,024 $9,005 $ 9,999
====== ====== =======
Policyholders' benefits ceded $ 519 $ 530 $ 571
====== ====== =======
Reinsurance recoverables, included in "Other assets" in the Company's
Consolidated Statements of Financial Position, at December 31, were as
follows:
1998 1997
------ ------
(In Millions)
Life insurance $ 620 $ 685
Property-casualty 564 554
Other reinsurance 92 65
------ ------
$1,276 $1,304
====== ======
28
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
8. SHORT-TERM AND LONG-TERM DEBT
Debt consists of the following at December 31:
SHORT-TERM DEBT
1998 1997
------- ------
(In Millions)
Commercial paper $ 7,057 $4,268
Notes payable 2,164 2,151
Current portion of long-term debt 861 355
------- ------
Total short-term debt $10,082 $6,774
======= ======
The weighted average interest rate on outstanding short-term debt was
approximately 5.4% and 6.0% at December 31, 1998 and 1997, respectively.
The Company issues commercial paper primarily to manage operating cash flows and
existing commitments, meet working capital needs and take advantage of current
investment opportunities. Commercial paper borrowings are supported by various
lines of credit.
LONG-TERM DEBT
<TABLE>
<CAPTION>
DESCRIPTION MATURITY DATES RATE 1998 1997
- ----------- -------------- ---- ----- ----
(In Millions)
<S> <C> <C> <C> <C>
Floating rate notes ("FRN") 1999 - 2005 4.04-14.00%(a) $ 729 $ 324
Long term notes 1999 - 2023 5.5% - 12% 1,318 910
Zero coupon notes 1999 8.6% (b) 364 334
Canadian dollar notes - 7.0% - 9.125% - 117
Japanese yen notes 1999 - 2000 0.5% - 4.6% 160 178
Swiss francs notes - 3.875% - 120
Canadian dollar FRN 2003 5.25%-5.89% 96 96
Surplus notes 2003 - 2025 6.875% - 8.3% 987 986
Senior notes 1999 - 2006 6.375% 393 -
Commercial paper backed by long-term
credit agreements 1,500 1,500
Other notes payable 1999 - 2017 4% - 7.5% 48 63
------- -------
Subtotal 5,595 4,628
Less: current portion of long-term debt (861) (355)
------- -------
Total long-term debt $ 4,734 $ 4,273
======= =======
</TABLE>
(a) The Company issued an S&P 500 index linked note of $29 million in September
of 1997. The interest rate on the note is based on the appreciation of the
S&P 500 index, with a contractual cap of 14%. At December 31, 1998, this
rate was 14%. Excluding this note, floating rate note interest rates were
between 4.04% - 5.50%.
(b) The rate shown for zero coupon notes represents a level yield to maturity.
29
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
8. SHORT-TERM AND LONG-TERM DEBT (CONTINUED)
Payment of interest and principal on the surplus notes issued after 1993,
of which $686 million were outstanding at December 31, 1998, may be made
only with the prior approval of the Commissioner of Insurance of the State
of New Jersey.
In order to modify exposure to interest rate and currency exchange rate
movements, the Company utilizes derivative instruments, primarily interest
rate swaps, in conjunction with some of its debt issues. The effect of
these derivative instruments is included in the calculation of the
interest expense on the associated debt, and as a result, the effective
interest rates on the debt may differ from the rates reflected in the
tables above. Floating rates are determined by formulas and may be subject
to certain minimum or maximum rates.
Scheduled principal repayments of long-term debt as of December 31, 1998,
are as follows: $862 million in 1999, $560 million in 2000, $327 million
in 2001, $1,816 million in 2002, $458 million in 2003 and $1,575 million
thereafter.
At December 31, 1998, the Company had $9,853 million in lines of credit
from numerous financial institutions of which $8,330 million were unused.
These lines of credit generally have terms ranging from one to five years.
Interest expense for short-term and long-term debt is $920 million,
$743 million and $618 million for the years ended December 31, 1998, 1997
and 1996, respectively.
9. EMPLOYEE BENEFIT PLANS
PENSION AND OTHER POSTRETIREMENT PLANS
The Company has funded non-contributory defined benefit pension plans
which cover substantially all of its employees. The Company also has
several non-funded non-contributory defined benefit plans covering
certain executives. Benefits are generally based on career average
earnings and credited length of service. The Company's funding policy is
to contribute annually an amount necessary to satisfy the Internal
Revenue Service contribution guidelines.
The Company provides certain life insurance and health care benefits
("Other postretirement benefits") for its retired employees, their
beneficiaries and covered dependents. The healthcare plan is
contributory; the life insurance plan is non-contributory. Substantially
all of the Company's employees may become eligible to receive benefits if
they retire after age 55 with at least 10 years of service or under
certain circumstances after age 50 with at least 20 years of continuous
service. These benefits are funded as considered necessary by Company
management.
The Company has elected to amortize its transition obligation for other
postretirement benefits over 20 years.
30
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
Prepaid and accrued benefit costs are included in "Other assets" and
"Other liabilities", respectively, in the Company's Consolidated
Statements of Financial Position. The status of these plans as of
September 30, adjusted for fourth quarter activity, is summarized below:
<TABLE>
<CAPTION>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
---------------------- ------------------------
1998 1997 1998 1997
-------- ------- ------- -------
(In Millions) (In Millions)
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at the beginning of period $(5,557) $(5,148) $(2,128) $(2,002)
Service cost (159) (127) (35) (38)
Interest cost (397) (376) (142) (149)
Plan participants' contributions - - ( 6) (4)
Amendments (58) - - 31
Actuarial losses (600) (334) (31) (84)
Transfer to third party - 32 - -
Contractual termination benefits (30) (63) - -
Benefits paid 485 460 128 117
Foreign currency changes 7 (1) 1 1
------- ------- ------- -------
Benefit obligation at end of period $(6,309) $(5,557) $(2,213) $(2,128)
======= ======= ======= =======
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of period $ 8,489 $ 7,306 $ 1,354 $ 1,313
Actual return on plan assets 445 1,693 146 120
Transfer to third party (4) (32) - -
Contribution from pension plan - - 31 25
Employer contributions 25 16 13 9
Plan participants' contributions - - 6 4
Withdrawal under IRS Section 420 (36) (35) - -
Benefits paid (485) (460) (128) (117)
Foreign currency changes (7) 1 - -
------- ------- ------- -------
Fair value of plan assets at end of period $ 8,427 $ 8,489 $ 1,422 $ 1,354
======= ======= ======= =======
FUNDED STATUS:
Funded status at end of period $ 2,118 $ 2,932 $ (791) $ (774)
Unrecognized transition (asset) liability (554) (661) 660 707
Unrecognized prior service cost 335 327 - -
Unrecognized actuarial net gain (813) (1,644) (353) (364)
Effects of 4th quarter activity (9) (63) 2 33
------- ------- ------- -------
Net amount recognized $ 1,077 $ 891 $ (482) $ (398)
======= ======= ======= =======
AMOUNTS RECOGNIZED IN THE STATEMENTS OF FINANCIAL
POSITION CONSIST OF:
Prepaid benefit cost $ 1,348 $ 1,150 $ - $ -
Accrued benefit liability (287) (270) (482) (398)
Intangible asset 7 5 - -
Accumulated other comprehensive income 9 6 - -
-------- -------- -------- ---------
Net amount recognized $ 1,077 $ 891 $ (482) $ (398)
======== ======== ======== =========
</TABLE>
31
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for the pension plan with accumulated benefit
obligations in excess of plan assets were $384 million, $284 million and
$0, respectively, as of September 30, 1998 and $319 million, $226 million
and $ 0, respectively, as of September 30, 1997.
The effects of fourth quarter activity are summarized as follows:
<TABLE>
<CAPTION>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
---------------------- -----------------------
1998 1997 1998 1997
------ ------- ------ ------
(In Millions)
<S> <C> <C> <C> <C>
Effect of IRS Section 420 transfer $ - $ (36) $ - $ -
Contractual termination benefits (14) (30) - -
Contribution from pension plan - - - 31
Employer contributions 5 3 2 2
----- ------- ------ ------
Effects of 4th quarter activity $ (9) $ (63) $ 2 $ 33
====== ======= ====== ======
</TABLE>
Pension plan assets consist primarily of equity securities, bonds, real estate
and short-term investments, of which $5,926 million and $6,022 million are
included in Separate Account assets and liabilities at September 30, 1998 and
1997, respectively.
Other postretirement plan assets consist of group and individual variable life
insurance policies, group life and health contracts, common stocks, U.S.
government securities and short-term investments. Plan assets include $1,018
million and $1,044 million of Company insurance policies and contracts at
September 30, 1998 and 1997, respectively.
Effective December 31, 1996, The Prudential Securities Incorporated Cash Balance
Plan (the "PSI Plan") was merged into The Retirement System for United States
Employees and Special Agents of The Prudential Insurance Company of America (the
"Prudential Plan"). The name of the merged plan is The Prudential Merged
Retirement Plan ("Merged Retirement Plan"). All of the assets of the Merged
Retirement Plan are available to pay benefits to participants and their
beneficiaries who are covered by the Merged Retirement Plan. The merger of the
plans had no effect on the December 31, 1996 results of operations.
During 1996, the Prudential Plan was amended to provide cost of living
adjustments for retirees. The effect of this plan amendment increased benefit
obligations and unrecognized prior service cost by $170 million at September 30,
1996. In addition, the Prudential Plan was amended to provide contractual
termination benefits to certain plan participants who were notified between
September 15, 1996 and December 31, 1998 that their employment had been
terminated. Costs related to these amendments are reflected below in contractual
termination benefits.
32
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
Net periodic benefit cost included in "General and administrative expenses"
in the Company's Consolidated Statements of Operations for the years ended
December 31, includes the following components:
<TABLE>
<CAPTION>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
----------------------------------- ------------------------------------
1998 1997 1996 1998 1997 1996
----------------------------------- ------------------------------------
(In Millions)
<S> <C> <C> <C> <C> <C> <C>
COMPONENTS OF NET PERIODIC BENEFITS COSTS:
Service cost $ 159 $ 127 $ 140 $ 35 $ 38 $ 45
Interest cost 397 376 354 142 149 157
Expected return on plan assets (674) (617) (594) (119) (87) (93)
Amortization of transition amount (106) (106) (107) 47 50 53
Amortization of prior service cost 45 42 26 - - -
Amortization of actuarial net (gain) loss 1 - - (13) (13) (3)
Curtailment gain (loss) 5 - - - - (9)
Contractual termination benefits 14 30 63 - - -
------- ------- ------- ------- ------- ------
Net periodic (benefit) cost $ (159) $ (148) $ (118) $ 92 $ 137 $ 150
======= ======= ======= ======= ======= ======
</TABLE>
The assumptions at September 30, used by the Company to calculate the benefit
obligations as of that date and to determine the benefit cost in the subsequent
year are as follows:
<TABLE>
<CAPTION>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------------------ ----------------------------------------
1998 1997 1996 1998 1997 1996
------------------------------ ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED-AVERAGE ASSUMPTIONS:
Discount rate 6.50% 7.25% 7.75% 6.50% 7.25% 7.75%
Rate of increase in compensation levels 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%
Expected return on plan assets 9.50% 9.50% 9.50% 9.00% 9.00% 9.00%
Health care cost trend rates - - - 7.80-11.00% 8.20-11.80% 8.50-12.50%
Ultimate health care cost trend rate
after gradual decrease until 2006 - - - 5.00% 5.00% 5.00%
</TABLE>
33
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. EMPLOYEE BENEFIT PLANS (CONTINUED)
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plan. A one-percentage point
increase and decrease in assumed health care cost trend rates would have
the following effects:
OTHER
POSTRETIREMENT BENEFITS
-----------------------
1998
------
(In Millions)
ONE PERCENTAGE POINT INCREASE
Effect on total service and interest costs $ 24
Effect on postretirement benefit obligation (226)
ONE PERCENTAGE POINT DECREASE
Effect on total service and interest costs $ (19)
Effect on postretirement benefit obligation 187
POSTEMPLOYMENT BENEFITS
The Company accrues postemployment benefits primarily for life and health
benefits provided to former or inactive employees who are not retirees. The
net accumulated liability for these benefits at December 31, 1998 and 1997
was $135 million and $144 million, respectively, and is included in "Other
liabilities."
OTHER EMPLOYEE BENEFITS
The Company sponsors voluntary savings plans for employees (401(k) plans).
The plans provide for salary reduction contributions by employees and
matching contributions by the Company of up to 3% of annual salary,
resulting in $54 million, $63 million and $57 million of expenses included in
"General and administrative expenses" for 1998, 1997 and 1996, respectively.
DISCONTINUED OPERATIONS
In connection with the disposal of the Company's HealthCare business, as more
fully discussed in Note 3, the loss on disposal was reduced by an estimated
curtailment gain of $30 million.
34
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
10. INCOME TAXES
The components of income tax expense for the years ended December 31, were
as follows:
1998 1997 1996
------ ------ ------
(In Millions)
Current tax expense (benefit):
U.S. $ 983 $ (14) $ 400
State and local 54 51 108
Foreign 148 64 48
------ ------ ------
Total $1,185 $ 101 $ 556
====== ====== ======
Deferred tax expense (benefit):
U.S. $ (193) $ 269 $ (428)
State and local (6) 4 (2)
Foreign (16) 33 54
------ ------ ------
Total $ (215) $ 306 $ (376)
====== ====== ======
Total income tax expense $ 970 $ 407 $ 180
====== ====== ======
The Company's income tax expense for the years ended December 31, differs from
the amount computed by applying the expected federal income tax rate of 35% to
income from continuing operations before income taxes for the following reasons:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(In Millions)
<S> <C> <C> <C>
Expected federal income tax expense $ 908 $ 480 $ 539
Equity tax (benefit) 75 (65) (365)
State and local income taxes 31 37 69
Tax-exempt interest and dividend received deduction (46) (67) (67)
Other
2 22 4
------ ------ ------
Total income tax expense $ 970 $ 407 $ 180
====== ====== ======
</TABLE>
35
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
10. INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities at December 31, resulted from the items
listed in the following table:
1998 1997
------- -------
(In Millions)
Deferred tax assets
Insurance reserves $ 1,584 $ 1,482
Policyholder dividends 265 250
Net operating loss carryforwards 260 80
Litigation related reserves 104 178
Employee benefits 63 42
Other 134 287
------- -------
Deferred tax assets before valuation allowance 2,410 2,319
Valuation allowance (13) (18)
------- -------
Deferred tax assets after valuation allowance 2,397 2,301
------- -------
Deferred tax liabilities
Investments 1,414 1,867
Deferred policy acquisition costs 1,436 1,525
Depreciation 64 36
------- -------
Deferred tax liabilities 2,914 3,428
------- -------
Net deferred tax liability $ 517 $ 1,127
======= =======
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
asset after valuation allowance. 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. At December 31, 1998 and 1997,
respectively, the Company had federal life net operating loss carryforwards of
$540 million and $1,200 million, which expire by 2012. At December 31, 1998 and
1997, respectively, the Company had state non-life operating loss carryforwards
for tax purposes approximating $1,059 million and $800 million, which expire by
2018.
The Internal Revenue Service (the "Service") has completed all examinations of
the consolidated federal income tax returns through 1989. The Service has
examined the years 1990 through 1992. Discussions are being held with the
Service with respect to proposed adjustments. Management, however, believes
there are adequate defenses against, or sufficient reserves to provide for such
adjustments. The Service has begun their examination of the years 1993 through
1995.
36
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
11. STATUTORY EQUITY AND INCOME
Applicable insurance department regulations require that the Company
prepare statutory financial statements in accordance with statutory
accounting practices prescribed or permitted by the New Jersey Department
of Banking and Insurance. Statutory accounting practices primarily differ
from GAAP by charging policy acquisition costs to expense as incurred,
establishing future policy benefits reserves using different actuarial
assumptions, not providing for deferred taxes, and valuing securities on a
different basis. The Company's statutory net income, as filed with the New
Jersey Department of Banking and Insurance was $1,247 million, $1,471
million and $1,402 million for the years 1998, 1997 and 1996,
respectively. Statutory capital and surplus, as filed, at December 31,
1998 and 1997 was $8,536 million and $9,242 million, respectively.
12. OPERATING LEASES
The Company and its subsidiaries occupy leased office space in many
locations under various long-term leases and have entered into numerous
leases covering the long-term use of computers and other equipment. At
December 31, 1998, future minimum lease payments under non-cancelable
operating leases are estimated as follows:
(In Millions)
1999 $ 295
2000 263
2001 231
2002 198
2003 157
Remaining years after 2003 753
-------
Total $ 1,897
=======
Amounts presented in the table above include operating leases relating to
the Company's HealthCare business. See Note 3 for a discussion of the
pending sale of this business. Amounts applicable to the HealthCare
business are $65 million in 1999, $58 million in 2000, $52 million in
2001, $45 million in 2002, $34 million in 2003 and $89 million thereafter.
Rental expense incurred for the years ended December 31, 1998, 1997 and
1996 was approximately $320 million, $352 million and $343 million,
respectively.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values presented below have been determined using
available information and valuation methodologies. Considerable judgment
is applied in interpreting data to develop the estimates of fair value.
Accordingly, such estimates presented may not be realized in a current
market exchange. The use of different market assumptions and/or estimation
methodologies could have a material effect on the estimated fair values.
The following methods and assumptions were used in calculating the
estimated fair values (for all other financial instruments presented in
the table, the carrying value approximates estimated fair value).
37
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
13. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
FIXED MATURITIES AND EQUITY SECURITIES
Estimated fair values for fixed maturities and equity securities, other
than private placement securities, are based on quoted market prices or
estimates from independent pricing services. Fair values for private
placement securities are estimated using a discounted cash flow model
which considers the current market spreads between the U.S. Treasury yield
curve and corporate bond yield curve, adjusted for the type of issue, its
current credit quality and its remaining average life. The fair value of
certain non-performing private placement securities is based on amounts
estimated by management.
MORTGAGE LOANS ON REAL ESTATE
The estimated fair value of the mortgage loan portfolio is primarily based
upon the present value of the scheduled future cash flows discounted at
the appropriate U.S. Treasury rate, adjusted for the current market spread
for a similar quality mortgage. For certain non-performing loans, the
estimated fair value is based upon the present value of expected future
cash flows discounted at the appropriate U.S. Treasury rate adjusted for
current market spread for a similar quality mortgage.
POLICY LOANS
The estimated fair value of policy loans is calculated using a discounted
cash flow model based upon current U.S. Treasury rates and historical loan
repayments.
DERIVATIVE FINANCIAL INSTRUMENTS
The fair value of swap agreements is estimated based on the present value
of future cash flows under the agreements discounted at the applicable
zero coupon U.S. Treasury rate and swap spread. The fair value of
forwards, futures and options is estimated based on market quotes for a
transaction with similar terms. The estimated fair value of loan
commitments is derived by comparing the contractual stream of fees with
such fee streams adjusted to reflect current market rates that would be
applicable to instruments of similar type, maturity, and credit standing.
POLICYHOLDERS' ACCOUNT BALANCES
Estimated fair values of policyholders' account balances are derived by
using discounted projected cash flows, based on interest rates being
offered for similar contracts, with maturities consistent with those
remaining for the contracts being valued. For interest sensitive life
contracts, fair value approximates carrying value.
DEBT
The estimated fair value of short-term and long-term debt is derived by
using discount rates based on the borrowing rates currently available to
the Company for debt with similar terms and remaining maturities.
38
<PAGE>
- -------------------------------------------------------------------------------
13. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The following table discloses the carrying amounts and estimated fair
values of the Company's financial instruments at December 31:
<TABLE>
<CAPTION>
1998 1997
----------------------- ------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(In Millions)
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Other than trading:
Fixed maturities:
Available for sale $ 80,158 $ 80,158 $ 75,270 $ 75,270
Held to maturity 16,848 17,906 18,700 19,894
Equity securities 2,759 2,759 2,810 2,810
Mortgage loans on real estate 16,495 17,265 16,004 16,703
Policy loans 7,476 8,037 7,034 7,201
Securities purchased under agreements to resell 1,737 1,737 - -
Short-term investments 9,781 9,781 12,106 12,106
Cash 1,943 1,943 1,859 1,859
Restricted Assets 2,366 2,366 1,835 1,835
Separate Account assets 81,621 81,621 73,839 73,839
Derivative financial instruments 132 135 93 92
Trading:
Trading account assets $ 8,888 $ 8,888 $ 6,347 $ 6,347
Broker-dealer related receivables 10,142 10,142 8,442 8,442
Derivative financial instruments 765 765 910 910
Securities purchased under agreements to resell 8,515 8,515 8,661 8,661
Cash collateral for borrowed securities 5,622 5,622 5,047 5,047
FINANCIAL LIABILITIES:
Other than trading:
Policyholders' account balances $ 30,974 $ 31,940 $ 33,246 $ 34,201
Securities sold under agreements to repurchase 7,085 7,085 85 85
Cash collateral for loaned securities 2,450 2,450 9,647 9,647
Short-term and long-term debt 14,816 15,084 11,047 11,131
Securities sold but not yet purchased 2,215 2,215 - -
Separate Account liabilities 80,931 80,931 73,451 73,451
Derivative financial instruments 390 391 100 99
Trading:
Broker-dealer related payables $ 6,530 $ 6,530 $ 3,338 $ 3,338
Derivative financial instruments 725 725 1,019 1,019
Securities sold under agreements to repurchase 14,401 14,401 12,262 12,262
Cash collateral for loaned securities 4,682 4,682 4,470 4,470
Securities sold but not yet purchased 3,556 3,556 3,648 3,648
</TABLE>
39
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
14. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
INTEREST RATE SWAPS
The Company uses interest rate swaps to reduce market risks from changes in
interest rates and to alter interest rate exposures arising from mismatches
between assets and liabilities. Under interest rates swaps, the Company
agrees with other parties to exchange, at specified intervals the difference
between fixed-rate and floating-rate interest amounts calculated by
reference to an agreed notional principal amount. Generally, no cash is
exchanged at the outset of the contract and no principal payments are made
by either party. Cash is paid or received based on the terms of the swap.
These transactions are entered into pursuant to master agreements that
provide for a single net payment to be made by one counterparty at each due
date. The fair value of swap agreements is estimated based on the present
value of future cash flows under the agreements, discounted at the
applicable zero coupon U.S. Treasury rate and swap spread.
If swap agreements meet the criteria for hedge accounting, net interest
receipts or payments are accrued and recognized over the life of the swap
agreements as an adjustment to interest income or expense of the hedged
item. Any unrealized gains or losses are not recognized until the hedged
item is sold or matures. Gains or losses on early termination of interest
rate swaps are deferred and amortized over the remaining period originally
covered by the swaps. If the criteria for hedge accounting are not met, the
swap agreements are accounted for at market value with changes in fair value
reported in current period earnings.
FUTURES AND OPTIONS
The Company uses exchange-traded Treasury futures and options to reduce
market risks from changes in interest rates, to alter mismatches between the
duration of assets in a portfolio and the duration of liabilities supported
by those assets, and to hedge against changes in the value of securities it
owns or anticipates acquiring. The Company enters into exchange-traded
futures and options with regulated futures commissions merchants who are
members of a trading exchange. The fair value of futures and options is
based on market quotes for transactions with similar terms.
Under exchange-traded futures, the Company agrees to purchase a specified
number of contracts with other parties and to post variation margin on a
daily basis in an amount equal to the difference in the daily market values
of those contracts. Futures are typically used to hedge duration mismatches
between assets and liabilities by replicating Treasury performance. Treasury
futures move substantially in value as interest rates change and can be used
to either modify or hedge existing interest rate risk. This strategy
protects against the risk that cash flow requirements may necessitate
liquidation of investments at unfavorable prices resulting from increases in
interest rates. This strategy can be a more cost effective way of
temporarily reducing the Company's exposure to a market decline than selling
fixed income securities and purchasing a similar portfolio when such a
decline is believed to be over.
If futures meet hedge accounting criteria, changes in their fair value are
deferred and recognized as an adjustment to the carrying value of the hedged
item. Deferred gains or losses from the hedges for interest-bearing
financial instruments are amortized as a yield adjustment over the remaining
lives of the hedged item. Futures that do not qualify as hedges are carried
at fair value with changes in value reported in current period earnings. The
gains and losses associated with anticipatory transactions are not material.
40
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
14. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (CONTINUED)
When the Company anticipates a significant decline in the stock market
which will correspondingly affect its diversified portfolio, it may
purchase put index options where the basket of securities in the index is
appropriate to provide a hedge against a decrease in the value of the
equity portfolio or a portion thereof. This strategy effects an orderly
sale of hedged securities. When the Company has large cash flows which it
has allocated for investment in equity securities, it may purchase call
index options as a temporary hedge against an increase in the price of the
securities it intends to purchase. This hedge permits such investment
transactions to be executed with the least possible adverse market impact.
Option premium paid or received is reported as an asset or liability and
amortized into income over the life of the option. If options meet the
criteria for hedge accounting, changes in their fair value are deferred
and recognized as an adjustment to the hedged item. Deferred gains or
losses from the hedges for interest-bearing financial instruments are
recognized as an adjustment to interest income or expense of the hedged
item. If the options do not meet the criteria for hedge accounting, they
are fair valued, with changes in fair value reported in current period
earnings.
CURRENCY DERIVATIVES
The Company uses currency derivatives, including exchange-traded currency
futures and options, currency forwards and currency swaps to reduce market
risks from changes in currency values of investments denominated in
foreign currencies that the Company either holds or intends to acquire and
to alter the currency exposures arising from mismatches between such
foreign currencies and the U.S. Dollar.
Under currency forwards, the Company agrees with other parties upon
delivery of a specified amount of specified currency at a specified future
date. Typically, the price is agreed upon at the time of the contract and
payment for such a contract is made at the specified future date. Under
currency swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between one currency and another at a
forward exchange rate and calculated by reference to an agreed principal
amount. Generally, the principal amount of each currency is exchanged at
the beginning and termination of the currency swap by each party. These
transactions are entered into pursuant to master agreements that provide
for a single net payment to be made by one counterparty for payments made
in the same currency at each due date.
If currency derivatives are effective as hedges of foreign currency
translation and transaction exposures, gains or losses are recorded in
"Accumulated other comprehensive income." If currency derivatives do not
meet hedge accounting criteria, gains or losses from those derivatives are
recognized in current period earnings.
The tables below summarize the Company's outstanding positions by
derivative instrument types as of December 31, 1998 and 1997. The amounts
presented are classified as either trading or other than trading, based on
management's intent at the time of contract inception and throughout the
life of the contract. The table includes the estimated fair values of
outstanding derivative positions only and does not include the changes in
fair values of associated financial and non-financial assets and
liabilities, which generally offset derivative notional amounts. The fair
value amounts presented also do not reflect the netting of amounts
pursuant to right of setoff, qualifying master netting agreements with
counterparties or collateral arrangements.
41
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
14. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS
DECEMBER 31, 1998
(In Millions)
<TABLE>
<CAPTION>
TRADING OTHER THAN TRADING TOTAL
------------------------- ------------------------- -------------------------
ESTIMATED ESTIMATED ESTIMATED
NOTIONAL FAIR VALUE NOTIONAL FAIR VALUE NOTIONAL FAIR VALUE
-------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Swaps:
Assets $ 4,564 $ 309 $ 2,200 $ 96 $ 6,764 $ 405
Liabilities 4,734 274 3,065 349 7,799 623
Forwards:
Assets 45,651 282 1,004 14 46,655 296
Liabilities 39,153 280 2,039 37 41,192 317
Futures:
Assets 3,272 61 1,786 23 5,058 84
Liabilities 4,371 47 531 5 4,902 52
Options:
Assets 8,310 113 130 2 8,440 115
Liabilities 6,388 124 213 - 6,601 124
-------- -------- -------- ------- -------- --------
Total:
Assets $ 61,797 $ 765 $ 5,120 $ 135 $ 66,917 $ 900
======== ======== ======== ======= ======== ========
Liabilities $ 54,646 $ 725 $ 5,848 $ 391 $ 60,494 $ 1,116
======== ======== ======== ======= ======== ========
</TABLE>
42
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
14. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS
DECEMBER 31, 1997
(In Millions)
<TABLE>
<CAPTION>
TRADING OTHER THAN TRADING TOTAL
-------------------------- ------------------------- --------------------------
ESTIMATED ESTIMATED ESTIMATED
NOTIONAL FAIR VALUE NOTIONAL FAIR VALUE NOTIONAL FAIR VALUE
-------- ----------- -------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Swaps:
Assets $ 5,798 $ 316 $ 1,446 $ 67 $ 7,244 $ 383
Liabilities 5,439 418 1,197 70 6,636 488
Forwards:
Assets 29,947 438 1,171 25 31,118 463
Liabilities 29,985 461 687 8 30,672 469
Futures:
Assets 4,103 51 46 - 4,149 51
Liabilities 3,064 50 3,320 21 6,384 71
Options:
Assets 6,893 105 239 - 7,132 105
Liabilities 3,946 90 224 - 4,170 90
------- ------- ------- ------ ------- -------
Total:
Assets $46,741 $ 910 $ 2,902 $ 92 $49,643 $ 1,002
======= ======= ======= ====== ======= =======
Liabilities $42,434 $ 1,019 $ 5,428 $ 99 $47,862 $ 1,118
======= ======= ======= ====== ======= =======
</TABLE>
CREDIT RISK
The current credit exposure of the Company's derivative contracts is limited to
the fair value at the reporting date. Credit risk is managed by entering into
transactions with creditworthy counterparties and obtaining collateral where
appropriate and customary. The Company also attempts to minimize its exposure to
credit risk through the use of various credit monitoring techniques. At December
31, 1998 and 1997 approximately 97% and 95%, respectively, of the net credit
exposure for the Company from derivative contracts is with investment-grade
counterparties.
Net trading revenues for the years ended December 31, 1998, 1997 and 1996
relating to forwards, futures and swaps were $67 million, $(5) million and $(13)
million; $59 million, $37 million and $(13) million; and $42 million, $32
million and $(11) million, respectively. Net trading revenues for options were
not material. Average fair values for trading derivatives in an asset position
during the years ended December 31, 1998 and 1997 were $1,165 million and $1,015
million, respectively, and for derivatives in a liability position were $1,140
million and $1,166 million, respectively. Of those derivatives held for trading
purposes at December 31, 1998, 63% of the notional amount consisted of interest
rate derivatives, 32% consisted of foreign currency derivatives, and 5%
consisted of equity and commodity derivatives. Of those derivatives held for
purposes other than trading at December 31, 1998, 60% of notional consisted of
interest rate derivatives, 31% consisted of foreign currency derivatives, and 9%
consisted of equity and commodity derivatives.
43
<PAGE>
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
14. DERIVATIVE AND OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS (CONTINUED)
OFF-BALANCE SHEET CREDIT-RELATED INSTRUMENTS
During the normal course of its business, the Company utilizes financial
instruments with off-balance sheet credit risk such as commitments,
financial guarantees, loans sold with recourse and letters of credit.
Commitments include commitments to purchase and sell mortgage loans, the
underfunded portion of commitments to fund investments in private placement
securities, and unused credit card and home equity lines. In connection
with the Company's commercial banking business, loan commitments for credit
cards and home equity lines of credit include agreements to lend up to
specified limits to customers. It is anticipated that commitment amounts
will only be partially drawn down based on overall customer usage patterns,
and, therefore, do not necessarily represent future cash requirements. The
Company evaluates each credit decision on such commitments at least
annually and has the ability to cancel or suspend such lines at its option.
The total available lines of credit card and home equity commitments were
$3.0 billion of which $2.2 billion remains available at December 31, 1998.
Also in connection with the Company's investment banking activities, the
Company enters into agreements with mortgage originators and others to
provide financing on both a secured and unsecured basis. Aggregate
financing commitments on a secured basis approximate $6.1 billion of which
$3.3 billion remains available at December 31, 1998. Unsecured commitments
approximate $65.0 million, the majority of which is outstanding at December
31, 1998.
Other commitments substantially include commitments to purchase and sell
mortgage loans and the underfunded portion of commitments to fund
investments in private placement securities. These mortgage loans and
private commitments were $2.5 billion of which $1.8 billion remain
available at December 31, 1998. Additionally, mortgage loans sold with
recourse were $0.5 billion at December 31, 1998.
The Company also provides financial guarantees incidental to other
transactions and letters of credit that guarantee the performance of
customers to third parties. 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. The Company seeks to control credit risk associated with these
instruments by limiting credit, maintaining collateral where customary and
appropriate, and performing other monitoring procedures. At December 31,
1998 these were immaterial.
15. DIVESTITURE
On July 31, 1996, the Company sold a substantial portion of its Canadian
Branch business to the London Life Insurance Company ("London Life"). This
transaction was structured as a reinsurance transaction whereby London Life
assumed total liabilities of the Canadian Branch equal to $3,291 million as
well as a related amount of assets equal to $3,205 million. This transfer
resulted in a reduction of policy liabilities of $3,257 million and a
corresponding reduction in invested assets. The Company recognized an
after-tax gain in 1996 of $116 million as a result of this transaction,
recorded in "Realized investment gains, net."
16. CONTINGENCIES AND LITIGATION
STOP-LOSS REINSURANCE AGREEMENT
In connection with the sale in 1995 of its wholly-owned subsidiary
Prudential Reinsurance Company ("Pru Re"), the Company's subsidiary,
Gibraltar Casualty Insurance Company ("Gibraltar") entered into a stop-loss
reinsurance agreement with Pru Re whereby Gibraltar has reinsured up to
$375 million of the first $400 million of aggregate adverse loss
development on reserves recorded by Pru Re at June 30, 1995. The Company
has guaranteed
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THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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16. CONTINGENCIES AND LITIGATION (CONTINUED)
Gibraltar's obligations arising under the stop-loss agreement subject to a
limit of $375 million. Through December 31, 1998, Gibraltar has incurred
$375 million in losses under the stop-loss agreement, including $90 million
in 1998. Gibraltar has paid $197 million to Pru Re under the stop-loss
agreement.
ENVIRONMENTAL AND ASBESTOS-RELATED CLAIMS
Certain of the Company's subsidiaries received claims under expired
contracts which assert alleged injuries and/or damages relating to or
resulting from toxic torts, toxic waste and other hazardous substances. The
liabilities for such claims cannot be estimated by traditional reserving
techniques. As a result of judicial decisions and legislative actions, the
coverage afforded under these contracts may be expanded beyond their
original terms. Extensive litigation between insurers and insureds over
these issues continues and the outcome is not predictable. In establishing
the liability for unpaid claims for these losses, management considered the
available information. However, given the expansion of coverage and
liability by the courts and legislatures in the past, and potential for
other unfavorable trends in the future, the ultimate cost of these claims
could increase from the levels currently established.
MANAGED CARE REIMBURSEMENT
The Company has reviewed its obligations under certain managed care
arrangements for possible failure to comply with contractual and regulatory
requirements. It is the opinion of management that adequate reserves have
been established to provide for appropriate reimbursements to customers.
REINSURANCE AND PARTICIPATION AGREEMENT
The Company and a number of other insurers ("the Consortium") entered into
a Reinsurance and Participation Agreement (the "Agreement") with MBL Life
Assurance Corporation ("MBLLAC") and others, under which the Company and
the other insurers agreed to reinsure certain payments to be made to
contract holders by MBLLAC in connection with the plan of rehabilitation of
Mutual Benefit Life Insurance Company. Under the agreement, the Consortium,
subject to certain terms and conditions, will indemnify MBLLAC for the
ultimate net loss sustained by MBLLAC on each contract subject to the
Agreement. The ultimate net loss represents the amount by which the
aggregate required payments exceed the fair market value of the assets
supporting the covered contracts at the time such payments are due. The
Company's share of any net loss is 30.55%. The Company has determined that
it does not expect to make any payments to MBLLAC under the agreement. The
Company concluded this after testing a wide range of potentially adverse
scenarios during the rehabilitation period for MBLLAC. In November 1998,
the Rehabilitation Court approved the sale of MBLLAC's individual life
insurance and individual group annuity business to affiliates of SunAmerica
Inc. Upon the end of the rehabilitation period, expected during 1999, the
agreement will terminate.
LITIGATION
Various lawsuits against the Company have arisen in the course of the
Company's business. In certain of these matters, large and/or indeterminate
amounts are sought.
Two putative class actions and approximately 320 individual actions were
pending against the Company in the United States as of January 31, 1999
brought on behalf of those persons who purchased life insurance policies
allegedly because of deceptive sales practices engaged in by the Company
and its insurance agents in violation of state and federal laws. Additional
suits may be filed by individuals who opted out of the class action
settlement described below. The sales practices alleged to have occurred
are contrary to Company policy. Some of these cases seek substantial
damages while others seek unspecified compensatory, punitive and treble
damages. The Company intends to defend these cases vigorously.
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THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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16. CONTINGENCIES AND LITIGATION (CONTINUED)
A Multi-State Life Insurance Task Force (the "Task Force"), comprised of
insurance regulators from 29 states and the District of Columbia, was
formed in April 1995 to conduct a review of sales and marketing practices
throughout the life insurance industry. The Company was the initial focus
of the Task Force examination. On July 9, 1996, the Task Force released its
report on the Company's activities. The Task Force found that some sales of
life insurance policies by the Company had been improper and that the
Company's efforts to prevent such practices were not sufficiently
effective. Based on the findings, the Task Force recommended, and the
Company agreed to, various changes to its sales and business practices
controls, and a series of fines allocated to all 50 states and the District
of Columbia. In addition, the Task Force recommended a remediation program
pursuant to which the Company would offer relief to the policyowners who
were misled when they purchased permanent life insurance policies in the
United States from 1982 to 1995.
On October 28, 1996, the Company entered into a Stipulation of Settlement
with attorneys for the plaintiffs in the consolidated class action lawsuit
pending in a Multi-District Litigation proceeding in the U.S. District
Court for the District of New Jersey. The class action suit involved
alleged improprieties in connection with the Company's sale, servicing and
operation of permanent life insurance policies from 1982 through 1995.
Pursuant to the settlement, the Company agreed to provide certain
enhancements and changes to the remediation program previously accepted by
the Task Force, including some additional remedies. In addition, the
Company agreed that it would incur a minimum cost of $410 million in
providing remedies to policyowners under the program and, in specified
circumstances, agreed to make certain other payments and guarantees. Under
the terms of the settlement, the Company agreed to a minimum average cost
per remedy of $2,364 for up to 330,000 claims remedied and also agreed to
provide additional compensation to be determined by formula that will range
in aggregate amount from $50 million to $300 million depending on the total
number of claims remedied. At the end of the remediation program's claim
evaluation process, the Court will determine how the additional
compensation will be distributed.
The terms of the remediation program described above were enhanced again in
February 1997 pursuant to agreements reached with several states that had
not previously accepted the terms of the program. These changes were
incorporated as amendments to the above-described Stipulation of Settlement
and related settlement documents, and the amended Stipulation of Settlement
was approved as fair to class members by the U.S. District Court in March
1997. By that point in time, the Company had entered into agreements with
all 50 states and the District of Columbia pursuant to which each
jurisdiction had accepted the remediation plan and the Company had agreed
to pay approximately $65 million in fines, penalties and related payments.
The decision of the U.S. District Court to certify a class in the
above-described litigation for settlement purposes only and to approve the
class action settlement as described in the amended Stipulation of
Settlement was affirmed by the U.S. Court of Appeals for the Third Circuit
in July 1998 although the issue of class counsel's fees was sent back to
the U.S. District Court for review. The Supreme Court denied certiorari in
January 1999, thereby making final the approval of the class action
settlement.
While the approval of the class action settlement is now final, the Company
remains subject to oversight and review by insurance regulators and other
regulatory authorities with respect to its sales practices and the conduct
of the remediation program. The releases granted by the state insurance
regulators pursuant to the individual state settlement agreements do not
become final until the remediation program has been completed without any
material changes to which those regulators have not agreed. The U.S.
District Court has also retained jurisdiction as to all matters relating to
the administration, consummation, enforcement and interpretation of the
class action settlement.
Pursuant to the state agreements and the amended Stipulation of Settlement,
as approved by the U.S. District Court, the Company initiated its
remediation program in 1997. The Company mailed packages and provided broad
class notice to the owners of approximately 10.7 million policies eligible
to participate in the remediation program in
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THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
16. CONTINGENCIES AND LITIGATION (CONTINUED)
October 1996, informing them of their rights. Owners of approximately
21,800 policies elected to be excluded from the class action settlement. Of
those eligible to participate in the settlement, policyowners who believed
they were misled were invited to file a claim through an Alternative
Dispute Resolution ("ADR") process. The ADR process was established to
enable the Company to discharge its liability to the affected policyowners.
Policyowners who did not wish to file a claim in the ADR process were
permitted to choose from options available under Basic Claim Relief, such
as preferred rate premium loans, or annuities, mutual fund shares or life
insurance policies that the Company will enhance.
In January 1997 the U.S. District Court sanctioned and fined the Company
$1 million for failure to properly implement procedures for its employees
to retain documents in violation of the Courts' order that required the
parties to preserve all documents relevant to the class action and
remediation program. The Court ordered the Company to implement a document
retention policy and directed that an independent expert be engaged to
investigate the extent of document destruction and its impact on the
remediation program.
In response to the class notices, the owners of approximately 503,000
policies indicated an interest in a Basic Claim Relief remedy. Management
believes that costs associated with providing Basic Claim Relief will not
be material to the Company's financial position or results of operations.
The owners of approximately 1.16 million policies responded to the class
notices by indicating an intent to file an ADR claim. All policyholders
who responded were provided an ADR claim form for completion and
submission. The ADR process generally requires that individual claim forms
and files be reviewed by the Company and by one or more independent claim
evaluators. Approximately 649,000 claim forms were completed and returned
and approximately 591,000 decision letters had been mailed to claimants as
of January 31, 1999. In many instances, claimants have the right to
"appeal" the Company's decision to an independent reviewer. Management
believes that the bulk of such appeals will be resolved in 1999.
In 1996, the Company recorded in its Consolidated Statement of Operations
the cost of $410 million as a guaranteed minimum remediation expense
pursuant to the settlement agreement. Management had no better information
available at that time upon which to make a reasonable estimate of losses
associated with the settlement. In 1997, based on additional information
derived from claim sampling techniques, the terms of the settlement and
the number of claim forms received, management increased the estimated
liability for the cost of remedying policyholder claims in the ADR process
by $1.64 billion before taxes to approximately $2.05 billion before taxes,
of which $1.80 billion was funded in a settlement trust. Management
expressly noted that additional cost items were anticipated that could not
be fully evaluated at that time.
In 1998, based on estimates derived from an analysis of claims actually
remedied (including interest), a sample of claims still to be remedied, an
estimate of additional liability associated with the results of the
investigation by the independent expert regarding the impact of document
destruction on the ADR program, and an estimate of additional liabilities
associated with a claimant's right to "appeal" the Company's decision,
management increased the estimated liability for the cost of ADR remedies
by $.51 billion before taxes to a total of $2.56 billion before taxes, all
of which has been funded in a settlement trust as discussed in Note 4. The
Company has also recorded from 1996 through 1998 additional charges to
reflect ongoing administrative costs related to the ADR program,
regulatory fines, penalties and related payments, litigation costs and
settlements, and other fees and expenses associated with the resolution of
sales practices issues. While management believes the foregoing provisions
are reasonable estimates based on information currently available, the
ultimate amount of the total cost of remedied policyholder claims and
other related costs is dependent on complex and varying factors, including
the relief options still to be chosen by claimants, the dollar value of
those options, and the number and type of claims that may successfully be
appealed.
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THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
16. CONTINGENCIES AND LITIGATION (CONTINUED)
The Company's litigation is subject to many uncertainties, and given the
complexity and scope, the outcomes cannot be predicted with precision. It
is possible that the results of operations or the cash flow of the Company,
in particular quarterly or annual periods, could be materially affected by
an ultimate unfavorable outcome of the matters specifically discussed
above. Management believes, however, that the ultimate resolution of all
such matters, after consideration of applicable reserves, should not have a
material adverse effect on the Company's financial position.
******
48
