Derivative Instruments

12 Months Ended

Dec. 31, 2012

Derivative Instruments

Derivative Instruments

11.DERIVATIVE INSTRUMENTS

Types of Derivative Instruments and Derivative Strategies

Interest Rate Contracts 

Interest rate swaps are used by the Company toreduce risks from changes in interest rates, manage interest rate exposures arising from mismatches between assets and liabilities (including duration mismatches) and to hedge against changes in the value of assets it owns or anticipates acquiring or selling. Swaps may be attributed to specific assets or liabilities or may be used on a portfolio basis. Under interest rate 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 upon notional principal amount. Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. 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.

Equity Contracts 

Equity index options are contracts which will settle in cash based on differentials in the underlying indices at the time of exercise and the strike price. The Company uses combinations of purchases and sales of equity index options to hedge the effects of adverse changes in equity indices within a predetermined range. These hedges do not qualify for hedge accounting.

Foreign Exchange Contracts

Currency derivatives, including currency swaps,are used by the Company to reduce risks from changes in currency exchange rates with respect to investments denominated in foreign currencies that the Company either holds or intends to acquire or sell, and to hedge the currency risk associated with net investments in foreign operations and anticipated earnings of its foreign operations.

Under currency swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between one currency and another at an 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.

Credit Contracts

Credit derivatives are used by the Company to enhance the return on the Company's investment portfolio by creating credit exposure similar to an investment in public fixed maturity cash instruments. With credit derivatives the Company sells credit protection on an identified name, and in return receives a quarterly premium. With credit default derivatives, this premium or credit spread generally corresponds to the difference between the yield on the referenced name's public fixed maturity cash instruments and swap rates, at the time the agreement is executed. If there is an event of default by the referenced name, as defined by the agreement, then the Company is obligated to pay the counterparty the referenced amount of the contract and receive in return the referenced defaulted security or similar security or pay the referenced amount less the auction recovery rate. See credit derivatives written section for discussion of guarantees related to credit derivatives written. In addition to selling credit protection, the Company haspurchased credit protection using credit derivatives in order to hedge specific credit exposures in the Company's investment portfolio.

Embedded Derivatives

The Company sells variable annuity products, which may include guaranteed benefit features that are accountedfor as embedded derivatives. The Company has reinsurance agreements to transfer the risk related to certain of these embedded derivatives to affiliates, Pruco Reand Prudential Insurance. The embedded derivatives related to the living benefit features and the related reinsurance agreements are carried at fair value. These embedded derivatives are marked to market through “Realized investment gains (losses), net” based on the change in value of the underlying contractual guarantees, which are determined using valuation models, as described in Note10.

The fair value of the living benefit feature embedded derivatives included in "Future policy benefits" was a liability of $1,793 million and $1,784 million as of December 31, 2012 and December 31, 2011, respectively. The fair value of the embedded derivatives related to the reinsurance of certain of these benefits to Pruco Re and Prudential Insurance included in "Reinsurance recoverables" was an asset of $1,733 million and $1,748 million as of December 31, 2012 and December 31, 2011, respectively.

The Company invests in fixed maturities that, in addition to a stated coupon, provide a return based upon the results of an underlying portfolio of fixed income investments and related investment activity. The Company accounts for these investments as available-for-sale fixed maturities containing embedded derivatives. Such embedded derivatives are marked to market through “Realized investment gains (losses), net,” based upon the change in value of the underlying portfolio.

The table below provides a summary of the gross notional amount and fair value of derivatives contractsused in a non-dealer or broker capacity, excluding embedded derivatives which are recorded with the associated host, by the primary underlying. Many derivative instruments contain multiple underlyings.

	December 31, 2012							December 31, 2011
			Notional	Fair Value					Notional	Fair Value
			Amount	Assets		Liabilities			Amount	Assets		Liabilities
		(in thousands)
Derivatives Designated as Hedging Instruments:
Currency/Interest Rate		$	65,612	$	192	$	(3,309)	$	47,702	$	867	$	(1,796)
Total Qualifying Hedges		$	65,612	$	192	$	(3,309)	$	47,702	$	867	$	(1,796)
Derivatives Not Qualifying as Hedging Instruments:
Interest Rate
Interest Rate Swaps		$	2,332,950	$	139,258	$	(24,075)	$	1,652,950	$	145,380	$	(8,546)
Interest Rate Options			100,000		15,330		-		100,000		17,048		-
Currency/Interest Rate
Foreign Currency Swaps			61,126		1,715		(2,894)		62,280		2,852		(4,975)
Credit
Credit Default Swaps			345,050		411		(1,413)		399,050		1,737		(2,165)
Equity
Total Return Swaps			253,766		193		(3,741)		199,446		1,067		(4,838)
Equity Options			7,800,982		16,988		(6,920)		2,798,732		23,161		(17,692)
Total Non-Qualifying Hedges		$	10,893,874	$	173,895	$	(39,043)	$	5,212,458	$	191,245	$	(38,216)
Total Derivatives (1)		$	10,959,486	$	174,087	$	(42,352)	$	5,260,160	$	192,112	$	(40,012)

(1) Excludes embedded derivatives which contain multiple underlyings. The fair value of these embedded derivatives was a liabilityof $1,793million and $1,787million as of December 31, 2012 and December 31, 2011, respectively, included in “Future policy benefits” and “Fixed maturities, available-for-sale.”

Cash Flow Hedges

The primary derivative instruments used by the Company in its cash flow hedge accounting relationships are currency swaps. These instrumentsareonly designated for hedge accounting in instances where the appropriate criteria are met. The Company does not use futures, options, credit, equity or embedded derivatives in any of its cash flow hedge accounting relationships.

The following tables provide the financial statement classification and impact of derivatives used in qualifying and non-qualifying hedge relationships, excluding the offset of the hedged item in an effective hedge relationship:

		Year Ended December 31, 2012
			Realized Investment Gains/(Losses)		Net Investment Income		Other Income		Accumulated Other Comprehensive Income (1)
		(in thousands)
Derivatives Designated as Hedging Instruments:
Cash flow hedges
	Currency/Interest Rate	$	-	$	(116)	$	14	$	(2,106)
	Total cash flow hedges		-		(116)		14		(2,106)
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		5,030		-		-		-
	Currency		(15)		-		-		-
	Currency/Interest Rate		(1,368)		-		(17)		-
	Credit		143		-		-		-
	Equity		(56,158)		-		-		-
	Embedded Derivatives		(55,295)		-		-		-
	Total non-qualifying hedges		(107,663)		-		(17)		-
Total		$	(107,663)	$	(116)	$	(3)	$	(2,106)

(1) Amounts deferred in “Accumulated other comprehensive income (loss).”

		Year Ended December 31, 2011
			Realized Investment Gains/(Losses)		Net Investment Income		Other Income		Accumulated Other Comprehensive Income (1)
		(in thousands)
Derivatives Designated as Hedging Instruments:
Cash flow hedges
	Currency/Interest Rate	$	-	$	(89)	$	1	$	1,504
	Total cash flow hedges		-		(89)		1		1,504
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		114,601		-		-		-
	Currency/Interest Rate		1,281		-		-		-
	Credit		915		-		-		-
	Equity		(28,070)		-		-		-
	Embedded Derivatives		(100,093)		-		-		-
	Total non-qualifying hedges		(11,366)		-		-		-
Total		$	(11,366)	$	(89)	$	1	$	1,504

(1) Amounts deferred in “Accumulated other comprehensive income (loss).”

		Year Ended December 31, 2010
			Realized Investment Gains/(Losses)		Net Investment Income		Other Income		Accumulated Other Comprehensive Income (1)
		(in thousands)
Derivatives Designated as Hedging Instruments:
Cash flow hedges
	Currency/Interest Rate	$	-	$	61	$	(26)	$	(1,822)
	Total cash flow hedges		-		61		(26)		(1,822)
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		53,077		-		-		-
	Currency/Interest Rate		1,105		-		-		-
	Credit		873		-		-		-
	Equity		(10,865)		-		-		-
	Embedded Derivatives		(34,682)		-		-		-
	Total non-qualifying hedges		9,508		-		-		-
Total		$	9,508	$	61	$	(26)	$	(1,822)

(1) Amounts deferred in “Accumulated other comprehensive income (loss).”

For theyears ended December 31, 2012, 2011 and 2010,the ineffective portion of derivatives accounted for using hedge accounting wasnot material to the Company's results of operations and there were no material amounts reclassified into earnings relating to instances in which the Company discontinued cash flow hedge accounting because the forecastedtransaction did not occur by the anticipated date or within the additional time period permitted by the authoritative guidance for the accounting for derivatives and hedging.

Presented below is a rollforward of current period cash flow hedges in “Accumulated other comprehensive income (loss)” before taxes:

	(in thousands)
Balance, December 31, 2009	$	(640)
Net deferred gains (losses) on cash flow hedges from January 1 to December 31, 2010		(1,260)
Amount reclassified into current period earnings		(562)
Balance, December 31, 2010		(2,462)
Net deferred gains (losses) on cash flow hedges from January 1 to December 31, 2011		1,415
Amount reclassified into current period earnings		85
Balance, December 31, 2011		(962)
Net deferred gains (losses) on cash flow hedges from January 1 to December 31, 2012		(2,207)
Amount reclassified into current period earnings		101
Balance, December 31, 2012	$	(3,068)

As of December 31, 2012 and 2011, the Company did not have any qualifying cash flow hedges of forecasted transactions other than those related to the variability of the payment or receipt of interest or foreign currency amounts on existing financial instruments. The maximum length of time for which these variable cash flows are hedged is 21 years. Income amounts deferred in “Accumulated other comprehensive income (loss)” as a result of cash flow hedges are included in “Net unrealized investment gains (losses)” in the Statements of Equity.

Credit Derivatives Written

The following table sets forth the composition of the Company's credit derivatives where it has written credit protection, excluding embedded derivatives contained in externally-managed investments in European markets, by industry category as of the dates indicated.

		December 31, 2012				December 31, 2011
Industry		Notional		Fair Value		Notional		Fair Value
		(in thousands)
Corporate Securities:
	Consumer Non-cyclical	$	120,000	$	146	$	120,000	$	655
	Capital Goods		90,000		109		90,000		315
	Basic Industry		40,000		68		40,000		248
	Transportation		25,000		30		25,000		106
	Consumer Cyclical		20,000		29		20,000		120
	Energy		20,000		29		20,000		101
	Finance		-		-		54,000		95
Total Credit Derivatives		$	315,000	$	411	$	369,000	$	1,640

The Company writes credit derivatives under which the Company is obligated to pay a related party counterparty the referenced amount of the contract and receive in return the defaulted security or similar security. The Company's maximum amount at risk under these credit derivatives, assuming the value of the underlying referenced securities become worthless, is $315 million and $369 million notional of credit default swap (“CDS”) selling protection with an associated fair value of less than $1 million and $2 million, at December 31, 2012 and December 31, 2011, respectively. These credit derivatives generally have maturities of less than1 year. At December 31, 2012 andDecember 31, 2011, the underlying credits had NAIC designation ratings of 1 and 2.

The Company holds certain externally-managed investments in the European market which contain embedded derivatives whose fair values are primarily driven by changes in credit spreads. These investments are medium term notes that are collateralized by investment portfolios primarily consisting of investment grade European fixed income securities, including corporate bonds and asset-backed securities, and derivatives, as well as varying degrees of leverage. The notes have a stated coupon and provide a return based on the performance of the underlying portfolios and the level of leverage. The Company invests in these notes to earn a coupon through maturity, consistent with its investment purpose for other debt securities. The notes are accounted for under U.S. GAAP as available-for-sale fixed maturity securities with bifurcated embedded derivatives (total return swaps). Changes in the value of the fixed maturity securities are reported in Equity under the heading “Accumulated other comprehensive income (loss)” and changes in the market value of the embedded total return swaps are included in current period earnings in “Realized investment gains (losses), net.” The Company's maximum exposure to loss from these investmentswas $0 million and $7 million at December 31, 2012 and December 31, 2011, respectively. The fair value of the embedded derivatives included in “Fixed maturities, available-for-sale” was a liability of $0million and $3 million atDecember 31, 2012 and December 31, 2011, respectively.

In addition to writing credit protection, the Company has purchased credit protection using credit derivatives in order to hedge specific credit exposures in the Company's investment portfolio. As of December 31, 2012 and December 31, 2011, the Company had $30 million of outstanding notional amounts, respectively reported at fair value as a liability of$1million and $2million, respectively.

Counterparty Credit Risk

The Company is exposed to credit-related losses in the event of non-performance by our counterpartyto financial derivative transactions.

The Company has credit risk exposure to an affiliate, Prudential Global Funding (“PGF”), related to its OTC derivative transactions. PGF manages credit risk with external counterparties by entering into derivative transactions with highly rated major international financial institutions and other creditworthy counterparties, and by obtaining collateral where appropriate, see Note 13.Additionally, limits are set on single party credit exposures which are subject to periodic management review.

Under fair value measurements, the Company incorporates the market's perception of its own and the counterparty's non-performance risk in determining the fair value of the portion of its OTC derivative assets and liabilities that are uncollateralized. Credit spreads are applied to the derivative fair values on a net basis by counterparty. To reflect the Company's own credit spread a proxy based on relevant debt spreads is applied to OTC derivative net liability positions. Similarly, the Company's counterparty's credit spread is applied to OTC derivative net asset positions.