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Prudential Financial 2001 Annual Report - page 132 / 172

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132 / 172

Prudential Financial, Inc.

Notes to Consolidated Financial Statements

13.

Stockholders’ Equity (continued)

conversion, together with its affiliates, would be the beneficial owner (as defined under the Securities Exchange Act of 1934) of in excess of 9.9% of the total outstanding voting power of Prudential Financial’s voting securities. In the event a holder of shares of Class B Stock requests to convert shares pursuant to clause (2)(a) in the preceding sentence, Prudential Financial may elect, instead of effecting such conversion, to increase the Target Dividend Amount to $12.6875 per share per annum retroactively from the time of issuance of the Class B Stock.

Statutory Net Income and Surplus Prudential Financial’s insurance subsidiaries are required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of the state of domicile. Statutory accounting practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. Statutory net income (loss) of Prudential Insurance amounted to $(896) million, $149 million and $333 million for the years ended December 31, 2001, 2000 and 1999, respectively. Statutory surplus of Prudential Insurance amounted to $6,420 million and $8,640 million at December 31, 2001 and 2000, respectively.

14. Earnings Per Share

The Company has outstanding two separate classes of common stock. The Common Stock reflects the performance of the Financial Services Businesses, while the Class B Stock reflects the performance of the Closed Block Business. Accordingly, earnings per share is calculated separately for each of these two classes of common stock. Earnings per share amounts are based on the earnings available to common stockholders for the period subsequent to the date of demutualization.

Net income for the Financial Services Businesses and the Closed Block Business is determined in accordance with GAAP and includes general and administrative expenses charged to each of the respective businesses based on the Company’s methodology for the allocation of such expenses. The net income of each business is modified for cash flows between the Financial Services Businesses and the Closed Block Business related to administrative expenses, which are determined by a policy servicing fee arrangement that is based upon insurance in force and statutory cash premiums. To the extent actual administrative expenses vary from these cash flow amounts, the differences will be recorded, on an after tax basis, as direct equity adjustments to the respective equity balances of each business. The direct equity adjustments are used to adjust net income to determine the earnings available to each of the classes of common stockholders for earnings per share purposes.

The Financial Services Businesses will bear any expenses and liabilities from litigation affecting the Closed Block policies as well as the consequences of certain adverse tax determinations. In addition, in the year ended December 31, 2001 during the period prior to demutualization, a reserve of $144 million was recorded in the Traditional Participating Products segment for death and other benefits and related expenses due with respect to policies for which the Company has not received a death claim but where death has occurred. Upon demutualization, $134 million of this reserve became a liability of the Financial Services Businesses and any subsequent changes in this reserve will be included in the results of the Financial Services Businesses.

Common Stock The purchase contracts (see Note 12) are reflected in the diluted earnings per share calculation using the treasury stock method. Under this method, the number of shares of Common Stock used in calculating earnings per share for any period are deemed to be increased by the excess, if any, of the number of shares that would be required to be issued upon settlement of the purchase contracts over the number of shares that could be purchased in the market, at the average market price during that period, using the proceeds that would be required to be paid upon settlement. Consequently, the purchase contracts are dilutive to earnings per share when the average market price of the Common Stock is above $34.10.

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Growing and Protecting Your Wealth

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