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Prudential Financial 2001 Annual Report - page 90 / 172





90 / 172

Prudential Financial, Inc.

the time of demutualization, and reductions in bank borrowings associated with our broker-dealer operations. Long- term debt increased due to the issuance by PHLLC of $1.75 billion of IHC debt related to the establishment of the Closed Block Business. We have classified this debt as limited and non-recourse. In addition, long-term debt has also increased $599 million due to the acquisition of Gibraltar Life. The decline in asset-based financing relates primarily to reductions in asset-based financed positions in our spread and hedge portfolios.

Our short-term debt includes bank borrowings and commercial paper outstanding under Prudential Funding’s domestic and European commercial paper programs. The weighted average interest rates on the commercial paper borrowings under these programs were 4.22% for the year ended December 31, 2001; 6.31% for 2000 and 5.11% for 1999. The total principal amount of debt outstanding under Prudential Funding’s medium-term note programs was $2.0 billion at December 31, 2001; $1.6 billion at December 31, 2000 and $1.8 billion at December 31, 1999. The weighted average interest rates on Prudential Funding’s long-term debt, in the aggregate, were 5.94% for the year ended December 31, 2001; 6.67% for 2000 and 5.61% for 1999. See Note 11 to the Consolidated Financial Statements for additional information on our short-term and long-term debt.

We had outstanding surplus notes totaling $989 million at December 31, 2001 and $988 million at December 31, 2000. These debt securities, which are included as surplus of Prudential Insurance on a statutory accounting basis, are subordinate to other borrowings and to policyholder obligations and are subject to regulatory approvals for principal and interest payments.

The ratings assigned by independent rating agencies are an important determinant of the market acceptance and cost of our financing through commercial paper, medium-term notes, surplus notes and other indebtedness.

We use interest rate swaps to convert some of our fixed rate long-term debt to floating rates of interest and to convert some of our floating rate long-term debt to fixed rates of interest, to match the interest rate sensitivity of the positions financed. We hedge currency risks related to non-United States dollar borrowings by using foreign currency swaps and/or foreign exchange forward contracts. See “Quantitative and Qualitative Disclosures About Market Risk—Risk Management, Market Risk and Derivative Instruments—Other Than Trading Activities— Market Risk Related to Foreign Currency Exchange Rates” below.

IHC Debt Prudential Financial issued shares of Class B Stock to institutional investors in a private placement concurrently with the initial public offering of Common Stock. In connection with and at the time of the issuance of the Class B Stock, PHLLC also issued the IHC debt, a portion of which is insured by a bond insurer. We expect that the IHC debt will be serviced by, and holders of the Class B Stock will receive as dividends, net cash flows of the Closed Block Business over time if and when such funds are dividended out of Prudential Insurance.

Insurance, Annuities and Guaranteed Products Liquidity Our principal cash flow sources from insurance, annuities and guaranteed products are premiums and annuity considerations, investment and fee income, and investment maturities and sales. We supplement these cash inflows with financing activities. We actively use our balance sheet capacity for financing activities on a secured basis through securities lending, repurchase and dollar roll transactions and on an unsecured basis for temporary cash flow mismatch coverage. Historically, we have also used our balance sheet capacity to earn additional spread income, primarily through our debt-financed investment portfolio included in Corporate and Other operations, although this portfolio was substantially reduced in 2001.

Cash outflow requirements principally relate to benefits, claims, dividends paid to policyholders, and payments to contract holders as well as amounts paid to policyholders and contract holders in connection with surrenders, withdrawals and net policy loan activity. Uses of cash also include commissions, general and administrative expenses, purchases of investments, and debt service and repayments in connection with financing activities. Some of our products, such as guaranteed products offered to institutional customers of the Employee Benefits division, provide for payment of accumulated funds to the contract holder at a specified maturity date unless the contract holder elects to roll over the funds into another contract with us. We regularly monitor our liquidity requirements associated with policyholder and contractholder obligations so that we can manage cash inflows to match anticipated cash outflow requirements.

Gross account withdrawals, including those of Gibraltar Life, which we acquired in April 2001, amounted to $9.014 billion in the year ended December 31, 2001 and $8.165 billion in the year ended December 31, 2000. These withdrawals include contractually scheduled maturities of traditional guaranteed investment contracts totaling


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