Derivative Instruments

9 Months Ended

Sep. 30, 2013

Derivative Instruments

Derivative Instruments

5.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.

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 benefit features to affiliates, Pruco Reand Prudential Insurance. The embedded derivatives related to theliving 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 Note4.

The fair value of the living benefit featureembedded derivatives included in "Future policy benefits" was a liability of $1,304 million and $1,793 million as of September 30, 2013 and December 31, 2012, 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 $1,253 million and $1,733 million as of September 30, 2013 and December 31, 2012, respectively.

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

	September 30, 2013							December 31, 2012
			Notional	Gross Fair Value					Notional	Gross Fair Value
			Amount	Assets		Liabilities			Amount	Assets		Liabilities
		(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Currency/Interest Rate		$	72,247	$	361	$	(3,886)	$	65,612	$	192	$	(3,309)
Total Qualifying Hedges		$	72,247	$	361	$	(3,886)	$	65,612	$	192	$	(3,309)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate
Interest Rate Swaps		$	2,332,950	$	78,215	$	(77,657)	$	2,332,950	$	139,258	$	(24,075)
Interest Rate Options			100,000		8,476		-		100,000		15,330		-
Currency/Interest Rate
Foreign Currency Swaps			55,919		451		(1,912)		61,126		1,715		(2,894)
Credit
Credit Default Swaps			6,050		-		(125)		345,050		411		(1,413)
Equity
Total Return Swaps			207,007		3,893		(1,319)		253,766		193		(3,741)
Equity Options			9,145,307		11,662		(6,486)		7,800,982		16,988		(6,920)
Total Non-Qualifying Hedges		$	11,847,233	$	102,697	$	(87,499)	$	10,893,874	$	173,895	$	(39,043)
Total Derivatives (1)		$	11,919,480	$	103,058	$	(91,385)	$	10,959,486	$	174,087	$	(42,352)

(1) Excludes embedded derivatives which contain multiple underlyings. The fair value of these embedded derivatives was a liabilityof $1,304million and $1,793million as of September 30, 2013and December 31, 2012, respectively, included in “Future policy benefits.”

Offsetting Assets and Liabilities

The following table presents recognized derivative instruments (including bifurcated embedded derivatives)that are offset in the balance sheet, and/or are subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in the balance sheet.

	September 30, 2013
			Gross		Net
	Gross		Amounts		Amounts
	Amounts of		Offset in the		Presented in
	Recognized		Statement of		the Statement		Financial
	Financial		Financial		of Financial		Instruments/		Net
	Instruments		Position		Position		Collateral		Amount
	(in thousands)
Offsetting of Financial Assets:
Derivatives	$	103,058	$	(91,700)	$	11,358	$	30,143	$	41,501
Offsetting of Financial Liabilities:
Derivatives	$	91,385	$	(91,385)	$	-	$	-	$	-
	December 31, 2012
			Gross		Net
	Gross		Amounts		Amounts
	Amounts of		Offset in the		Presented in
	Recognized		Statement of		the Statement		Financial
	Financial		Financial		of Financial		Instruments/		Net
	Instruments		Position		Position		Collateral		Amount
	(in thousands)
Offsetting of Financial Assets:
Derivatives	$	174,087	$	(42,352)	$	131,735	$	-	$	131,735
Offsetting of Financial Liabilities:
Derivatives	$	42,352	$	(42,352)	$	-	$	-	$	-

For information regarding the rights of offset associated with the derivative assets and liabilities in the table above see “Credit Risk” below.

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:

		Three Months Ended September 30, 2013
			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	$	-	$	(17)	$	(30)	$	(2,781)
	Total cash flow hedges		-		(17)		(30)		(2,781)
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		(11,810)		-		-		-
	Currency/Interest Rate		(2,137)		-		(23)		-
	Credit		(28)		-		-		-
	Equity		(14,507)		-		-		-
	Embedded Derivatives		(44,453)		-		-		-
	Total non-qualifying hedges		(72,935)		-		(23)		-
Total		$	(72,935)	$	(17)	$	(53)	$	(2,781)
		Nine Months Ended September 30, 2013
			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	$	-	$	(68)	$	2	$	(438)
	Total cash flow hedges		-		(68)		2		(438)
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		(94,040)		-		-		-
	Currency/Interest Rate		(353)		-		18		-
	Credit		(86)		-		-		-
	Equity		(55,934)		-		-		-
	Embedded Derivatives		(12,187)		-		-		-
	Total non-qualifying hedges		(162,600)		-		18		-
Total		$	(162,600)	$	(68)	$	21	$	(438)
		Three Months Ended September 30, 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	$	-	$	(33)	$	(4)	$	(1,556)
	Total cash flow hedges		-		(33)		(4)		(1,556)
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		(2,942)		-		-		-
	Currency/Interest Rate		(1,446)		-		(7)		-
	Credit		(53)		-		-		-
	Equity		(21,383)		-		-		-
	Embedded Derivatives		(37,089)		-		-		-
	Total non-qualifying hedges		(62,913)		-		(7)		-
Total		$	(62,913)	$	(33)	$	(11)	$	(1,556)
		Nine Months Ended September 30, 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	$	-	$	(107)	$	30	$	(494)
	Total cash flow hedges		-		(107)		30		(494)
Derivatives Not Qualifying as Hedging Instruments:
	Interest Rate		22,912		-		-		-
	Currency/Interest Rate		(296)		-		20		-
	Credit		140		-		-		-
	Equity		(48,576)		-		-		-
	Embedded Derivatives		(51,769)		-		-		-
	Total non-qualifying hedges		(77,589)		-		20		-
Total		$	(77,589)	$	(107)	$	50	$	(494)

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

For the three and nine months ended September 30, 2013 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, 2012	$	(3,068)
Net deferred gains (losses) on cash flow hedges from January 1 to September 30, 2013		(504)
Amount reclassified into current period earnings		66
Balance, September 30, 2013	$	(3,506)

As of September 30, 2013, 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 20 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 Unaudited Interim Statements of Equity.

Credit Derivatives Written

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. As of September 30, 2013, the Company had no outstanding written credit derivatives.As of December 31, 2012, the Company's maximum amount at risk under these credit derivatives, assuming the value of the underlying referenced securities become worthless, was $315 million notional of credit default swap (“CDS”) selling protection with an associated fair value of less than $1 million. Theunderlying credits had NAIC designation ratings of 1 and 2.

The following table sets forth the composition of the Company's credit derivatives where it has written credit protection by industry category as of the dates indicated.

		September 30, 2013				December 31, 2012
Industry		Notional		Fair Value		Notional		Fair Value
		(in thousands)
Corporate Securities:
	Consumer Non-cyclical	$	-	$	-	$	120,000	$	146
	Capital Goods		-		-		90,000		109
	Basic Industry		-		-		40,000		68
	Transportation		-		-		25,000		30
	Consumer Cyclical		-		-		20,000		29
	Energy		-		-		20,000		29
Total Credit Derivatives		$	-	$	-	$	315,000	$	411

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 September 30, 2013 and December 31, 2012,the Company had $6 millionand $30 millionof outstanding notional amounts, reported at fair value as a liability of $0.1 million and$1million.

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, LLC (“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 7.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.