Edgar Filing: PRUDENTIAL FINANCIAL INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to

Commission File Number 001-16707

Prudential Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

New Jersey		22-3703799
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification Number)

751 Broad Street

Newark, New Jersey 07102

(973) 802-6000

(Address and Telephone Number of Registrant’s Principal Executive Offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

At October 31, 2003, 538,500,067 shares of the registrant’s Common Stock (par value $0.01) were outstanding. In addition, 2,000,000 shares of the registrant’s Class B Stock, for which there is no established public trading market, were outstanding.

TABLE OF CONTENTS

			Page Number
PART I	FINANCIAL INFORMATION
	Item 1.	Financial Statements:
		Unaudited Interim Consolidated Statements of Financial Position as of September 30, 2003, and December 31, 2002	3
		Unaudited Interim Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002	4
		Unaudited Interim Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2003	5
		Unaudited Interim Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002	6
		Notes to Unaudited Interim Consolidated Financial Statements	7
		Unaudited Interim Supplemental Combining Financial Information:
		Unaudited Interim Supplemental Combining Statements of Financial Position as of September 30, 2003, and December 31, 2002	33
		Unaudited Interim Supplemental Combining Statements of Operations for the three months ended September 30, 2003 and 2002	34
		Unaudited Interim Supplemental Combining Statements of Operations for the nine months ended September 30, 2003 and 2002	35
		Notes to Unaudited Interim Supplemental Combining Financial Information	36

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	38

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	107

	Item 4.	Controls and Procedures	107

PART II	OTHER INFORMATION
	Item 1.	Legal Proceedings	108

	Item 6.	Exhibits and Reports on Form 8-K	109

SIGNATURES			110

Throughout this Quarterly Report on Form 10-Q, “Prudential Financial” and the “Registrant” refer to Prudential Financial, Inc., the ultimate holding company for all of our companies. “Prudential Insurance” refers to The Prudential Insurance Company of America, before and after its demutualization on December 18, 2001 (the “date of demutualization”). “Prudential,” the “Company,” “we” and “our” refer to our consolidated operations before and after demutualization. The “Plan of Reorganization” refers to Prudential Insurance’s Plan of Reorganization, dated as of December 15, 2000, and as amended from time to time thereafter, relating to Prudential Insurance’s demutualization.

FORWARD-LOOKING STATEMENTS

Certain of the statements included in this Quarterly Report on Form 10-Q, including but not limited to those in the Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as “expects,” “believes,” “anticipates,” “includes,” “plans,” “assumes,” “estimates,” “projects,” “intends” or variations of such words are generally part of forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future developments and their potential effects upon Prudential Financial, Inc. and its subsidiaries. There can be no assurance that future developments affecting Prudential Financial, Inc. and its subsidiaries will be those anticipated by management. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties, and there are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including without limitation: general economic, market and political conditions, including the performance of financial markets, interest rate fluctuations and the continuing negative impact of the current economic environment; various domestic or international military or terrorist activities or conflicts; volatility in the securities markets; reestimates of our reserves for future policy benefits and claims; changes in our assumptions related to deferred policy acquisition costs; our exposure to contingent liabilities; catastrophe losses; investment losses and defaults; changes in our claims-paying or credit ratings; competition in our product lines and for personnel; fluctuations in foreign currency exchange rates and foreign securities markets; risks to our international operations; the impact of changing regulation or accounting practices; Prudential Financial, Inc.’s primary reliance, as a holding company, on dividends from its subsidiaries to meet debt payment obligations and the applicable regulatory restrictions on the ability of the subsidiaries to pay such dividends; adverse litigation results; and changes in tax law. Prudential Financial, Inc. does not intend, and is under no obligation, to update any particular forward-looking statement included in this Quarterly Report on Form 10-Q.

PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

SEPTEMBER 30, 2003 AND DECEMBER 31, 2002

(in millions, except share amounts)

	September 30, 2003			December 31, 2002
ASSETS
Fixed maturities:
Available for sale, at fair value (amortized cost: 2003—$123,780; 2002—$117,869)	$	132,372		$	125,463
Held to maturity, at amortized cost (fair value: 2003—$2,954; 2002—$2,673)		2,954			2,612
Trading account assets, at fair value		3,852			3,449
Equity securities, available for sale, at fair value (cost: 2003—$2,729; 2002—$2,849)		3,181			2,807
Commercial loans		19,131			19,287
Policy loans		8,288			8,827
Securities purchased under agreements to resell		1,276			4,844
Cash collateral for borrowed securities		—			4,978
Other long-term investments		6,921			5,408
Short-term investments		7,661			5,419

Total investments		185,636			183,094
Cash and cash equivalents		8,642			9,898
Accrued investment income		1,945			1,790
Broker-dealer related receivables		908			5,631
Deferred policy acquisition costs		7,527			7,031
Other assets		19,272			14,747
Separate account assets		101,841			70,555

TOTAL ASSETS	$	325,771		$	292,746


LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Future policy benefits	$	93,175		$	90,460
Policyholders’ account balances		48,269			46,280
Unpaid claims and claim adjustment expenses		3,201			3,428
Policyholders’ dividends		4,920			3,675
Securities sold under agreements to repurchase		10,013			14,902
Cash collateral for loaned securities		5,972			10,231
Income taxes payable		2,031			1,933
Broker-dealer related payables		1,951			4,838
Securities sold but not yet purchased		1,620			1,996
Short-term debt		5,117			3,469
Long-term debt		6,080			4,757
Other liabilities		20,090			14,202
Separate account liabilities		101,841			70,555

Total liabilities		304,280			270,726

Guaranteed beneficial interest in Trust holding solely debentures of Parent		—			690

COMMITMENTS AND CONTINGENCIES (See Note 12)

STOCKHOLDERS’ EQUITY
Preferred Stock ($.01 par value; 10,000,000 shares authorized; none issued)		—			—
Common Stock ($.01 par value; 1,500,000,000 shares authorized; 584,547,776 and 584,511,144 shares issued at September 30, 2003 and December 31, 2002, respectively)		6			6
Class B Stock ($.01 par value; 10,000,000 shares authorized; 2,000,000 shares issued and outstanding at September 30, 2003 and December 31, 2002)		—			—
Additional paid-in capital		19,555			19,513
Common Stock held in treasury, at cost (43,808,786 and 24,283,271 shares at September 30, 2003 and December 31, 2002, respectively)		(1,397	)		(743	)
Deferred compensation		(54	)		(21	)
Accumulated other comprehensive income		2,705			2,585
Retained earnings (deficit)		676			(10	)

Total stockholders’ equity		21,491			21,330

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	325,771		$	292,746

See Notes to Unaudited Interim Consolidated Financial Statements

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

(in millions, except per share amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
	(in millions)
REVENUES
Premiums	$	3,311		$	3,232		$	10,152		$	9,738
Policy charges and fee income		475			400			1,342			1,246
Net investment income		2,158			2,232			6,541			6,610
Realized investment gains (losses), net		82			(245	)		137			(885	)
Commissions and other income		678			978			2,643			3,051

Total revenues		6,704			6,597			20,815			19,760


BENEFITS AND EXPENSES
Policyholders’ benefits		3,267			3,213			10,085			9,758
Interest credited to policyholders’ account balances		459			468			1,366			1,365
Dividends to policyholders		637			688			1,943			2,052
General and administrative expenses		1,732			2,099			5,812			6,312
Loss on disposition of property and casualty insurance operations		34			—			489			—

Total benefits and expenses		6,129			6,468			19,695			19,487


INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		575			129			1,120			273

Income tax expense (benefit)		242			(159	)		388			(106	)

INCOME FROM CONTINUING OPERATIONS		333			288			732			379

Income (loss) from discontinued operations, net of taxes		(36	)		14			(43	)		8

NET INCOME	$	297		$	302		$	689		$	387


EARNINGS PER SHARE (See Note 9)
Financial Services Businesses
Basic and Diluted:
Income from continuing operations per share of Common Stock	$	0.50		$	0.67		$	1.15		$	1.33
Discontinued operations		(0.06	)		0.03			(0.08	)		0.01

Net income per share of Common Stock	$	0.44		$	0.70		$	1.07		$	1.34


Closed Block Business
Net income (loss) per share of Class B Stock	$	29.00		$	(49.50	)	$	50.00		$	(196.50	)

See Notes to Unaudited Interim Consolidated Financial Statements

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2003

(in millions)

	Common Stock				Class B Stock		Additional Paid-in Capital		Retained Earnings (Deficit)			Common Stock Held in Treasury			Deferred Compensation			Accumulated Other Comprehensive Income		Total Stockholders’ Equity
	Shares		Amount		Class B Stock		Additional Paid-in Capital		Retained Earnings (Deficit)			Common Stock Held in Treasury			Deferred Compensation			Accumulated Other Comprehensive Income		Total Stockholders’ Equity
Balance, December 31, 2002	560.2		$	6	$	—	$	19,513	$	(10	)	$	(743	)	$	(21	)	$	2,585	$	21,330
Treasury stock acquired	(22.6	)		—		—		—		—			(749	)		—			—		(749	)
Stock-based compensation programs	3.1			—		—		42		(3	)		95			(33	)		—		101
Comprehensive income:
Net income	—			—		—		—		689			—			—			—		689
Other comprehensive income, net of taxes	—			—		—		—		—			—			—			120		120

Total comprehensive income																					809

Balance, September 30, 2003	540.7		$	6	$	—	$	19,555	$	676		$	(1,397	)	$	(54	)	$	2,705	$	21,491

See Notes to Unaudited Interim Consolidated Financial Statements

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

(in millions)

	2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	689		$	387
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment (gains) losses, net		(137	)		885
Policy charges and fee income		(147	)		(345	)
Interest credited to policyholders’ account balances		1,366			1,365
Depreciation and amortization, including premiums and discounts		489			445
Net loss on business dispositions		494			—
Change in:
Deferred policy acquisition costs		(377	)		(101	)
Future policy benefits and other insurance liabilities		1,247			1,156
Trading account assets		(1,104	)		622
Income taxes payable		96			(165	)
Broker-dealer related receivables/payables		193			369
Securities purchased under agreements to resell		103			(835	)
Cash collateral for borrowed securities		(116	)		(481	)
Cash collateral for loaned securities		(511	)		(243	)
Securities sold but not yet purchased		(28	)		(374	)
Securities sold under agreements to repurchase		(1,194	)		2,585
Other, net		1,372			1,481

Cash flows from operating activities		2,435			6,751

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from the sale/maturity of:
Fixed maturities, available for sale		32,925			47,670
Fixed maturities, held to maturity		1,126			167
Equity securities, available for sale		697			1,384
Commercial loans		2,133			2,205
Other long-term investments		863			887
Payments for the purchase of:
Fixed maturities, available for sale		(37,254	)		(54,780	)
Fixed maturities, held to maturity		(1,437	)		(2,219	)
Equity securities, available for sale		(744	)		(2,338	)
Commercial loans		(1,723	)		(1,730	)
Other long-term investments		(771	)		(1,328	)
Acquisition of subsidiary, net of cash acquired		(946	)		—
Cash of operations contributed to Wachovia Securities, LLC		(229	)		—
Proceeds from sale of subsidiary, net of cash disposed		133			—
Short-term investments		(2,259	)		1,484

Cash flows used in investing activities		(7,486	)		(8,598	)

CASH FLOWS FROM FINANCING ACTIVITIES
Policyholders’ account deposits		7,213			6,688
Policyholders’ account withdrawals		(7,084	)		(5,633	)
Cash dividends paid on Common Stock		(43	)		—
Net increase (decrease) in short-term debt		3,852			(1,644	)
Proceeds from deferred compensation program		—			55
Treasury stock acquired		(750	)		(550	)
Treasury stock reissued for exercise of stock options		37			—
Proceeds from the issuance of long-term debt		1,495			47
Repayments of long-term debt		(832	)		(517	)
Cash payments to eligible policyholders		(93	)		(2,556	)

Cash flows from (used in) financing activities		3,795			(4,110	)

NET DECREASE IN CASH AND CASH EQUIVALENTS		(1,256	)		(5,957	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		9,898			18,536

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	8,642		$	12,579

See Notes to Unaudited Interim Consolidated Financial Statements

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

1. BUSINESS AND BASIS OF PRESENTATION

Prudential Financial, Inc. (“Prudential Financial”) and its subsidiaries (collectively, “Prudential” or the “Company”) provide a wide range of insurance, investment management, securities and other financial products and services to both retail and institutional customers throughout the United States and in many other countries. Principal products and services provided include life insurance, annuities, mutual funds, pension and retirement related investments and administration, asset management and securities brokerage. The Company has organized its principal operations into the Financial Services Businesses and the Closed Block Business. The Financial Services Businesses operate through three operating divisions: Insurance, Investment, and International Insurance and Investments. Businesses that are not sufficiently material to warrant separate disclosure and businesses to be divested are included in Corporate and Other operations within the Financial Services Businesses. The Closed Block Business, which includes the Closed Block (see Note 7), is managed separately from the Financial Services Businesses. The Closed Block Business was established on the date of demutualization and includes the Company’s in force participating insurance and annuity products and assets that are used for the payment of benefits and policyholder dividends on these products, as well as other assets and equity that support these products and related liabilities. In connection with the demutualization, the Company has ceased offering these participating products.

Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of Prudential Financial, its majority-owned subsidiaries and those partnerships and joint ventures in which the Company has a majority financial interest, except in those instances where the Company cannot exercise control because the minority owners have substantive participating rights in the operating and capital decisions of the entity. The unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) on a basis consistent with reporting interim financial information in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. 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, in particular deferred policy acquisition costs, investments, future policy benefits, disclosure of contingent 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.

In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations have been made. All such adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Company’s audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Reclassifications

Certain amounts in prior periods have been reclassified to conform to the current period presentation.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

2. NEW ACCOUNTING POLICIES AND PRONOUNCEMENTS

In April 2003, the Financial Accounting Standards Board (“FASB”) issued Statement No. 133 Implementation Issue No. B36, “Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor Under Those Instruments.” Implementation Issue No. B36 indicates that a modified coinsurance arrangement (“modco”), in which funds are withheld by the ceding insurer and a return on those withheld funds is paid based on the ceding company’s return on certain of its investments, generally contains an embedded derivative feature that is not clearly and closely related to the host contract and should be bifurcated in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities.”

At any time during the fiscal quarter that the guidance in Implementation Issue No. B36 is initially applied, companies that have ceded insurance under existing modco arrangements may reclassify securities from the held-to-maturity and available-for-sale categories into the trading category without calling into question the intent of those companies to hold other debt securities to maturity in the future; however, those “taint-free” reclassifications are limited to the amount and type of securities related to the embedded derivatives that are being newly accounted for as derivatives in conjunction with the initial application of that guidance to modco arrangements.

The effective date of Implementation Issue No. B36 is the first day of the first fiscal quarter beginning after September 15, 2003. Beginning in the fourth quarter of 2003 the Company intends to apply the guidance prospectively for existing contracts and all future transactions. As permitted by SFAS No. 133, all contracts entered into prior to January 1, 1999, were grandfathered and are exempt from the provisions of SFAS No. 133 that relate to embedded derivatives. Based upon the Company’s current level of modco and funds withheld reinsurance, the application of Implementation Issue No. B36 is not expected to have a material effect on the Company’s consolidated financial position or results of operations.

In January 2003, the FASB issued Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 addresses whether certain types of entities, referred to as variable interest entities (“VIEs”), should be consolidated in a company’s financial statements. A VIE is an entity that either (1) has equity investors that lack certain essential characteristics of a controlling financial interest (including the ability to control the entity, the obligation to absorb the entity’s expected losses and the right to receive the entity’s expected residual returns), or (2) lacks sufficient equity to finance its own activities without financial support provided by other entities, which in turn would be expected to absorb at least some of the expected losses of the VIE. FIN No. 46 requires that a VIE be consolidated by its “Primary Beneficiary.” The Primary Beneficiary is the entity, if any, that stands to absorb a majority of the VIE’s expected losses, or in the event that no entity stands to absorb a majority of the expected losses, then the entity that stands to receive a majority of the VIE’s expected residual returns. Expected losses and expected residual returns are generally meant to represent the probability-weighted variability of potential outcomes, above and below the probability-weighted average of potential outcomes (the expected outcome). The present value of fees payable by the VIE to a guarantor of all or some of the VIE’s beneficial interests, as well as fees payable to the VIE’s decision maker, are added to the expected residual returns, which was intended by FASB to result in an increased likelihood of consolidation of a VIE by its guarantor or decision maker, when no entity is expected to absorb a majority of the VIE’s expected losses.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

2. NEW ACCOUNTING POLICIES AND PRONOUNCEMENTS (continued)

The Company has determined that the implementation of FIN No. 46 will require consolidation of certain asset backed investment vehicles (commonly referred to as collateralized debt obligations, or “CDOs”). The Company believes the consolidation of CDOs will not have a material effect on the Company’s consolidated financial position. The FASB continues to provide additional interpretive guidance regarding certain aspects of FIN No. 46, including matters that may impact our conclusion that consolidation of CDOs is appropriate.

The Company manages the collateral owned by eight CDOs, for which the Company earns fee income. Additionally, the Company may invest in debt or equity securities issued by those CDOs, or by the CDOs managed by other companies. CDOs raise capital by issuing debt and equity securities, and use the proceeds to purchase investments, typically interest-bearing financial instruments. The investment returns are used by the CDO to finance its operations, including the payment of collateral management fees to the Company and interest payments on its debt. The net result of the CDO’s operations are shared by the owners of the CDO’s equity securities; in the case of net losses that exceed the equity investment, holders of debt securities share losses in ascending order of subordination. In some CDOs, a portion of positive returns is shared with the collateral manager through an incentive fee. As currently interpreted, a collateral manager is generally considered to be a VIE’s decision maker, and as a result of the treatment of decision maker fees in the determination of which entity is a VIE’s Primary Beneficiary, the Company expects to consolidate most of those CDOs for which it serves as collateral manager.

The Company has adopted FIN No. 46 for relationships with VIEs that began on or after February 1, 2003. One of the CDOs for which the Company acts as collateral manager was established in August 2003, and is therefore subject to FIN No. 46 from its inception. The CDO’s financial position as of September 30, 2003 and the results of its operations through September 30, 2003 are included in the Company’s consolidated financial statements. Invested assets of $262 million are included in “Trading account assets,” while cash equivalents of $63 million owned by the CDO are included in “Other assets,” and not “Cash and cash equivalents,” reflecting the Company’s restricted ability to use such cash and cash equivalents only in accordance with the CDO’s terms. Liabilities to unrelated parties of $308 million are included in “Other liabilities,” and primarily comprise obligations under debt instruments issued by the CDO, which are non-recourse to the Company. As of September 30, 2003, the Company’s maximum exposure to loss resulting from its relationship with this VIE is limited to $19 million, represented by its investment in the CDO of $6 million in equity securities and $13 million in debt securities.

In October 2003, the FASB deferred application of FIN No. 46 from July 1, 2003 to December 31, 2003, for VIEs entered into prior to February 1, 2003. Therefore, the Company will implement the consolidation guidance effective December 31, 2003, for VIEs with which the Company became involved prior to February 1, 2003. The Company’s investments in CDOs entered into prior to February 1, 2003, that may be consolidated as of December 31, 2003, are currently accounted for as Available for Sale fixed maturity investments. Investment income on such assets is accounted for on the prospective method in accordance with Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.” A cumulative effect adjustment would arise on consolidation of those CDOs representing the difference as of December 31, 2003 between the cumulative amounts recorded as net investment income through that date in accordance with EITF No. 99-20, and the Company’s share of the net income recorded by the CDOs. Under current guidance, where the CDO has experienced net losses in excess of its equity capital, the Company would reflect such excess losses as a component of the cumulative effect adjustment recorded at transition, and as a component of net income in

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

2. NEW ACCOUNTING POLICIES AND PRONOUNCEMENTS (continued)

periods subsequent to adoption. However, due to the non-recourse nature of the instruments issued by the CDO, any excess losses included in the Company’s determination of net income, that are not absorbed by debt instruments held by the Company, would reverse at maturity and be reflected as liability extinguishment gains.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 generally applies to instruments that are mandatorily redeemable, that represent obligations that will be settled with a variable number of company shares, or that represent an obligation to purchase a fixed number of company shares. For instruments within its scope, the statement requires classification as a liability with initial measurement at fair value. Subsequent measurement depends upon the certainty of the terms of the settlement (such as amount and timing) and whether the obligation will be settled by a transfer of assets or by issuance of a fixed or variable number of equity shares. The Company’s adoption of SFAS No. 150, as of July 1, 2003, resulted in a reclassification on the Company’s balance sheet of $690 million, from “Guaranteed beneficial interest in Trust holding solely debentures of Parent,” previously classified outside of liabilities as mezzanine equity, to “Long-term debt.” This obligation represents a mandatorily redeemable financial instrument under SFAS No. 150, which must be classified as a liability.

In November 2002, the FASB issued FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 expanded previously existing accounting guidance and disclosure requirements for certain guarantees and requires the recognition of a liability for the fair value of certain types of guarantees issued or modified after December 31, 2002. The January 1, 2003 adoption of the Interpretation’s guidance did not have a material effect on the Company’s consolidated financial position.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. Prior to the adoption of SFAS No. 146, certain costs associated with an exit or disposal activity were recorded upon the Company’s commitment to a restructuring plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company has adopted this statement for applicable transactions occurring on or after January 1, 2003.

In July 2003, the Accounting Standards Executive Committee (“AcSEC”) of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.” AcSEC has developed the SOP to address the evolution of product designs since the issuance of SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” and SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” and the need for interpretive guidance to be developed in three areas: separate account presentation and valuation; the accounting recognition given sales inducements (bonus interest, bonus credits, persistency bonuses); and the classification and valuation of certain long-duration contract liabilities.

The most significant accounting implications of the SOP are as follows: (1) reporting and measuring assets and liabilities of separate account products as general account assets and liabilities when specified criteria are not met; (2) reporting and measuring seed money in separate accounts as general account assets based on the insurer’s proportionate beneficial interest in the separate account’s underlying assets; (3) capitalizing sales

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

2. NEW ACCOUNTING POLICIES AND PRONOUNCEMENTS (continued)

inducements that meet specified criteria and amortizing such amounts over the life of the contracts using the same methodology as used for amortizing deferred acquisition costs, but immediately expensing those sales inducements accrued or credited if such criteria are not met; (4) recognizing contractholder liabilities for: (a) modified guaranteed (market value adjusted) annuities at accreted balances that do not include the then current market value surrender adjustment, (b) two-tier annuities at the lower (non-annuitization) tier account value, (c) persistency bonuses at amounts that are not reduced for expected forfeitures and (d) group pension participating and similar general account “pass through” contracts that are not accounted for under SFAS No. 133 at amounts based on the fair value of the assets or index that determines the investment return pass through; (5) establishing an additional liability for guaranteed minimum death and similar mortality and morbidity benefits only for contracts determined to have mortality and morbidity risk that is other than nominal and when the risk charges made for a period are not proportionate to the risk borne during that period; and (6) for contracts containing an annuitization benefits contract feature, if such contract feature is not accounted for under the provisions of SFAS No. 133 establishing an additional liability for the contract feature if the present value of expected annuitization payments at the expected annuitization date exceeds the expected account balance at the expected annuitization date.

The provisions of the SOP are effective for fiscal years beginning after December 15, 2003, and, as such, the Company will adopt the SOP effective January 1, 2004. The effect of initially adopting this SOP will be reported as a cumulative effect of a change in accounting principle. The Company is currently completing an assessment of the impact of the SOP on its operations; however, we do not believe that the implementation of the SOP will have a material effect on the Company’s consolidated financial position.

Beginning with the third quarter of 2003, the Company adopted a policy that historical and prospective earnings of its Japanese operations will be available for repatriation to the United States. This change resulted in an increase in deferred taxes of $138 million in the third quarter of 2003 and, accordingly, an increase in the Company’s effective tax rate for the three and nine months ended September 30, 2003.

See Note 10 for information pertaining to the Company’s accounting for employee stock options.

3. DISCONTINUED OPERATIONS

In the first quarter of 2003, the Company signed a definitive agreement to sell its specialty automobile insurance business, a component of its property and casualty insurance business. The sale was completed on August 1, 2003. In the third quarter of 2003, the Company decided to exit the consumer banking business. This business was previously reflected within the Financial Advisory segment. Results of both the specialty automobile insurance business and the consumer banking business are included in “Other” below.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

3. DISCONTINUED OPERATIONS (continued)

Results of operations of discontinued businesses, including charges upon disposition, are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
	(in millions)
International securities operations	$	(47)		$	(6	)	$	(91	)	$	(15	)
Web-based workplace distribution of voluntary benefits		—			(36	)		(1	)		(45	)
Healthcare operations		—			60			11			60
Other		(11	)		6			(24	)		15

Income (loss) from discontinued operations before income taxes		(58	)		24			(105	)		15
Income tax expense (benefit)		(22	)		10			(62	)		7

Income (loss) from discontinued operations, net of taxes	$	(36)		$	14		$	(43	)	$	8

The Company’s Unaudited Interim Consolidated Statements of Financial Position include total assets and total liabilities related to discontinued operations of $1.491 billion and $1.175 billion, respectively, at September 30, 2003, and $2.999 billion and $2.531 billion, respectively, at December 31, 2002.

4. DISPOSITION OF PROPERTY AND CASUALTY INSURANCE OPERATIONS

In the fourth quarter of 2003, the Company completed its previously announced agreements to sell its property and casualty insurance companies that operate nationally in 48 states outside of New Jersey, and the District of Columbia, to Liberty Mutual Group, as well as its New Jersey property and casualty insurance companies to Palisades Group. For the three and nine months ended September 30, 2003, the Company recognized a loss on disposition of $34 million and $489 million ($277 million after taxes), respectively, which primarily reflects the write-down of the assets to be sold to fair value and management’s best estimate of the cost of retained liabilities, including litigation exposure incurred before the closing and the estimated value of indemnification coverage provided in connection with potential adverse claim experience. It is possible that additional adjustments to this charge may be necessary, which could be material to future results of operations of a particular quarterly or annual period. The charge for the nine months ended September 30, 2003 includes a $57 million abandonment and impairment loss recorded in connection with certain long-lived assets.

In October 2003, property damage resulted from extensive fires in California. The Company’s current estimate of the impact of the fires on the sold businesses for the period prior to close of the transaction, based on information obtained to date, is a pretax loss of approximately $20 million. In addition, the Company entered into an agreement in November to sell Merastar Corporation (“Merastar”), its remaining subsidiary engaged in property and casualty insurance operations. This sale, which is expected to result in a pretax loss of approximately $15 million in the fourth quarter of 2003, is expected to close in late 2003 or early 2004. Assets and liabilities of the property and casualty insurance operations that are held for sale were $4.123 billion and $2.950 billion, respectively, at September 30, 2003.

5. ACQUISITION OF SKANDIA U.S. INC.

On May 1, 2003, the Company acquired Skandia U.S. Inc. (“Skandia U.S.”), a wholly owned subsidiary of Skandia Insurance Company Ltd. (“Skandia”). The Company purchased newly issued shares of common stock representing 90% of the outstanding common stock of Skandia U.S. and one share of a newly issued class of

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

5. ACQUISITION OF SKANDIA U.S. INC. (continued)

preferred stock (collectively the “Shares”) and entered into an agreement at the date of acquisition whereby the Company had the right to acquire, and Skandia had the right to require the Company to acquire, the remaining 10% of outstanding common stock. This agreement was accounted for as a financing transaction until the Company purchased the remaining 10% in the third quarter of 2003. The Company’s acquisition of Skandia U.S. included American Skandia, Inc. (“American Skandia”). American Skandia, through its wholly owned subsidiaries, is the largest distributor of variable annuities through independent financial planners in the U. S. and operates a mutual fund business. The acquisition will significantly increase the Company’s third party distribution capabilities in the U.S.

As of May 1, 2003, 100% of the assets acquired and liabilities assumed and the results of operations have been consolidated into the Company’s consolidated financial statements.

Purchase Price

The total purchase price was calculated as follows:

	(in millions)
Purchase price paid for the Shares(a)	$	646
Assumption of collateralized notes held by third parties		248
Purchase price for the remaining 10% equity of Skandia U.S.		165
Other payments to Skandia(b)		115
Transaction costs		10

Total purchase price(c )	$	1,184

Net Assets Acquired

The following table represents an allocation of the purchase price to assets acquired and liabilities assumed as follows:

	(in millions)
Total investments at market value	$	486
Cash and cash equivalents		238
Valuation of business acquired (“VOBA”)		440
Other assets at fair value		393
Separate account assets		22,311

Total assets acquired		23,868

Policyholder account balances		(168	)
Other liabilities at fair value		(205	)
Separate account liabilities		(22,311	)

Total liabilities assumed		(22,684	)

Net assets acquired(c)	$	1,184

(a)

The proceeds were used by Skandia U.S. to retire an aggregate of $646 million of unsecured debt and collateralized notes held by Skandia.

(b)

Prior to the Company’s acquisition of Skandia U.S., Skandia acquired certain subsidiaries of Skandia U.S. The cash Skandia paid to Skandia U.S. for these subsidiaries will be repaid to Skandia and is considered a component of the purchase price.

(c)

In May 2003, subsequent to the Company’s acquisition of Skandia U.S., Skandia U.S. paid a dividend to Prudential Financial of approximately $108 million, reducing the equity of Skandia U.S. by that amount.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

5. ACQUISITION OF SKANDIA U.S. INC. (continued)

VOBA

VOBA represents the present value of future profits embedded in the acquired contracts. The VOBA is determined by estimating the net present value of future cash flows expected to result from contracts in force at the date of the transaction. Future positive cash flows include fees and other charges assessed to the contracts for as long as they remain in force as well as fees collected upon surrender, while future negative cash flows include costs to administer the contracts, and benefit payments including payments under the guaranteed minimum death benefit (“GMDB”) provisions of the contracts. VOBA will be amortized over the expected life of the contracts (approximately 25 years) in proportion to estimated gross profits arising principally from investment results, mortality and expense margins, and surrender charges based upon historical and estimated future experience, which is updated periodically.

The GMDB provides annuity contract holders with a guarantee that the benefit received at death will be no less than a prescribed minimum amount. This minimum amount is based on the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract anniversary, or the greatest of these values, depending on features offered in various contracts and elected by the contract holders. These contracts generally require payment of additional charges for guarantees other than those based on net deposits paid into the contract. To the extent that the guaranteed minimum death benefit is higher than the current account value at the time of death, the Company may incur a loss on the contract. This results in increased annuity policy benefits in periods of declining financial markets, and also in periods of stable financial markets following a decline. Current accounting literature does not prescribe recognition of a liability for the expected future net costs associated with these guarantees, and accordingly, the opening statement of financial position of Skandia U.S. does not reflect a liability corresponding to these projected future obligations for death benefits in excess of annuity account values. However, AICPA SOP 03-01, effective for fiscal years beginning after December 15, 2003, requires the recording of a liability associated with these guarantees under certain circumstances. For contracts classified as insurance contracts that have amounts assessed against contractholders each period for the insurance benefit features that are assessed in a manner that is expected to result in profits in earlier years and subsequent losses from that insurance benefit function, a liability is required to be established in addition to the account balance to recognize the portion of such assessments that compensates the insurance enterprise for benefits to be provided in future periods. In valuing the contracts acquired, the Company considered the negative cash flows of future benefit obligations associated with the GMDB on those contracts.

Upon adoption of SOP 03-01 on January 1, 2004, the Company will establish an explicit liability for GMDB associated with the acquired contracts. This will result in an increase in VOBA and higher future amortization. The higher amortization will be partially offset by lower benefit expenses, as a portion of the future guaranteed minimum death benefit costs would be charged against the explicit GMDB liability.

The following table provides estimated future amortization of VOBA for the periods indicated. These amounts do not consider the effect of establishing the GMDB related liability described above.

		(in millions)
Remainder of 2003		$ 18
2004		64
2005		55
2006		47
2007		40
2008 and thereafter		192

Total		$416

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

5. ACQUISITION OF SKANDIA U.S. INC. (continued)

Information regarding the change in VOBA is as follows:

	Five Months Ended September 30, 2003
	(in millions)
Balance, May 1, 2003	$440
Interest	10
Amortization	(34	)

Balance, September 30, 2003	$416

Supplemental Pro Forma Information

The following table presents selected unaudited pro forma financial information of the Company, assuming that the Skandia U.S. acquisition had occurred January 1, 2002, for the three months ended September 30, 2002, and the nine months ended September 30, 2003 and 2002. The pro forma information presented does not purport to represent what the Company’s actual results of operations would have been if the acquisition had occurred as of the dates indicated or what such results would be for any future periods.

	Three months ended September 30,			Nine months ended September 30,
	2002			2003		2002
	(in millions, except per share data)
Total revenues	$	6,773		$	20,981	$	20,262
Income from continuing operations		344			761		523
Net income		358			718		531

Earnings per share:
Financial Services Businesses:
Income from continuing operations per share of Common Stock
Basic	$	0.77		$	1.21	$	1.58
Diluted	$	0.77		$	1.20	$	1.58
Net income per share of Common Stock
Basic	$	0.80		$	1.13	$	1.59
Diluted	$	0.80		$	1.12	$	1.59

Closed Block Business:
Income from continuing operations per share of Class B Stock
Basic and diluted	$	(49.50	)	$	50.00	$	(196.50	)
Net income per share of Class B Stock
Basic and diluted	$	(49.50	)	$	50.00	$	(196.50	)

6. INVESTMENT IN WACHOVIA SECURITIES, LLC

On July 1, 2003, the Company completed the previously announced agreement with Wachovia Corporation (“Wachovia”) to combine each company’s respective retail securities brokerage and clearing operations into a joint venture, Wachovia Prudential Financial Advisors, LLC. The joint venture conducts its operations through Wachovia Securities, LLC, which is headquartered in Richmond, VA. The Company has a 38% ownership

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

6. INVESTMENT IN WACHOVIA SECURITIES, LLC (continued)

interest in the joint venture, while Wachovia owns the remaining 62%. The transaction included the Company’s securities brokerage operations but did not include its equity sales, trading and research operations. The Company accounts for its 38% ownership of the joint venture under the equity method of accounting; periods prior to July 1, 2003, continue to reflect the results of the Company’s former independent securities brokerage operations on a fully consolidated basis.

Results for the three and nine months ended September 30, 2003 include a pre-tax gain of $19 million from the combination of the businesses. Results for the three and nine months ended September 30, 2003 also include transition costs, excluding transition costs incurred by the joint venture, of $18 million and $63 million, respectively, primarily related to retirement plan charges.

The Company recognized pre-tax equity earnings from Wachovia Securities of $31 million for the three months ended September 30, 2003, which includes $16 million of transition costs incurred by the venture during the period. The pre-tax equity earnings from Wachovia Securities are included in “Net investment income” within the Consolidated Statement of Operations. The Company’s investment in Wachovia Securities as of September 30, 2003 was $1.06 billion and is included in “Other long-term investments” in the Consolidated Statement of Financial Position.

7. CLOSED BLOCK

On the date of demutualization, Prudential Insurance established a Closed Block for certain individual life insurance policies and annuities issued by Prudential Insurance in the United States. The recorded assets and liabilities were allocated to the Closed Block at their historical carrying amounts. The Closed Block forms the principal component of the Closed Block Business. The Company established a separate closed block for participating individual life insurance policies issued by the Canadian branch of Prudential Insurance. Because of the substantially smaller number of outstanding Canadian policies, this separate closed block is insignificant in size and is not included in the information presented below.

The excess of Closed Block Liabilities over Closed Block Assets at the date of the demutualization (adjusted to eliminate the impact of related amounts in accumulated other comprehensive income) represented the estimated maximum future earnings at that date from the Closed Block expected to result from operations attributed to the Closed Block after income taxes. As required by AICPA Statement of Position 00-3, the Company developed an actuarial calculation of the timing of such maximum future earnings. If actual cumulative earnings of the Closed Block from inception through the end of any given period are greater than the expected cumulative earnings, only the expected earnings will be recognized in income. Any excess of actual cumulative earnings over expected cumulative earnings will represent undistributed accumulated earnings attributable to policyholders, which are recorded as a policyholder dividend obligation. The policyholder dividend obligation represents amounts to be paid to Closed Block policyholders as an additional policyholder dividend unless otherwise offset by future Closed Block performance that is less favorable than originally expected. If the actual cumulative earnings of the Closed Block from its inception through the end of any given period are less than the expected cumulative earnings of the Closed Block, the Company will recognize only the actual earnings in income. However, the Company may reduce policyholder dividend scales in the future, which would be intended to increase future actual earnings until the actual cumulative earnings equaled the expected cumulative earnings. As of September 30, 2003, actual cumulative earnings have been less than the expected cumulative earnings of the Closed Block; therefore, the Company has not recognized a policyholder dividend obligation for the excess of

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

7. CLOSED BLOCK (continued)

actual cumulative earnings over the expected cumulative earnings. However, net unrealized investment gains that have arisen subsequent to the establishment of the Closed Block have been reflected as a policyholder dividend obligation of $2,689 million at September 30, 2003, to Closed Block policyholders unless otherwise offset by future experience, with an offsetting amount reported in “Accumulated other comprehensive income.”

Closed Block Liabilities and Assets designated to the Closed Block as well as maximum future earnings to be recognized from Closed Block Liabilities and Closed Block Assets, are as follows:

	September 30, 2003			December 31, 2002
	(in millions)
Closed Block Liabilities
Future policy benefits	$	48,567		$	48,247
Policyholders’ dividends payable		1,231			1,151
Policyholder dividend obligation		2,689			1,606
Policyholders’ account balances		5,503			5,481
Other Closed Block liabilities		15,401			9,760

Total Closed Block Liabilities		73,391			66,245

Closed Block Assets
Fixed maturities:
Available for sale, at fair value	$	43,571		$	42,402
Equity securities, available for sale, at fair value		2,074			1,521
Commercial loans		6,469			6,457
Policy loans		5,556			5,681
Other long-term investments		1,019			1,008
Short-term investments		3,678			2,374

Total investments		62,367			59,443
Cash and cash equivalents		2,594			2,526
Accrued investment income		741			715
Other Closed Block assets		4,692			528

Total Closed Block Assets		70,394			63,212

Excess of reported Closed Block Liabilities over Closed Block Assets		2,997			3,033
Portion of above representing accumulated other comprehensive income:
Net unrealized investment gains		3,711			2,720
Allocated to policyholder dividend obligation		(2,689	)		(1,606	)

Future earnings to be recognized from Closed Block Assets and Closed Block Liabilities	$	4,019		$	4,147

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

7. CLOSED BLOCK (continued)

Information regarding the policyholder dividend obligation is as follows:

	Nine Months Ended September 30, 2003
	(in millions)
Balance, January 1, 2003	$	1,606
Impact on income before gains allocable to policyholder dividend obligation		—
Net investment gains		—
Unrealized investment gains		1,083

Balance, September 30, 2003	$	2,689

Closed Block revenues and benefits and expenses are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
	(in millions)
Revenues
Premiums	$	878		$	912		$	2,814		$	2,940
Net investment income		820			867			2,495			2,511
Realized investment gains (losses), net		109			(119	)		269			(345	)
Other income		11			20			51			58

Total Closed Block revenues		1,818			1,680			5,629			5,164

Benefits and Expenses
Policyholders’ benefits		935			963			3,056			3,152
Interest credited to policyholders’ account balances		35			34			103			102
Dividends to policyholders		607			655			1,830			1,946
General and administrative expenses		187			197			575			608

Total Closed Block benefits and expenses		1,764			1,849			5,564			5,808

Closed Block revenues, net of Closed Block benefits and expenses, before income taxes		54			(169	)		65			(644	)
Income tax (benefit) expense		(39	)		6			(63	)		(111	)

Closed Block revenues, net of Closed Block benefits and expenses and income taxes	$	93		$	(175	)	$	128		$	(533	)

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

8. STOCKHOLDERS’ EQUITY

Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003		2002
	(in millions)
Net income	$	297		$	302		$	689	$	387
Other comprehensive income (loss), net of taxes:
Change in foreign currency translation adjustments		42			(49	)		75		39
Change in net unrealized investment gains (losses)		(1,348	)		926			45		1,433

Other comprehensive income (loss)(1)		(1,306	)		877			120		1,472

Comprehensive income (loss)	$	(1,009	)	$	1,179		$	809	$	1,859

(1)

Amounts are net of income tax expense (benefit) of $(847) and $564 for the three months ended September 30, 2003 and 2002, respectively, and $(122) and $808 for the nine months ended September 30, 2003 and 2002, respectively.

The balance of and changes in each component of “Accumulated other comprehensive income” are as follows (net of taxes):

	Accumulated Other Comprehensive Income (Loss)
	Foreign Currency Translation Adjustments			Net Unrealized Investment Gains		Pension Liability Adjustment			Total Accumulated Other Comprehensive Income
	(in millions)
Balance, December 31, 2002	$	(154	)	$	2,834	$	(95	)	$	2,585
Change in component		75			45		—			120

Balance, September 30, 2003	$	(79	)	$	2,879	$	(95	)	$	2,705

9. EARNINGS PER SHARE

The Company has outstanding two separate classes of common stock. The Common Stock reflects the performance of the Financial Services Businesses and 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.

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. Cash flows between the Financial Services Businesses and the Closed Block Business related to administrative expenses are determined by a policy servicing fee arrangement that is based upon insurance and policies in force and statutory cash premiums. To the extent reported administrative expenses vary from these cash flow amounts, the differences are recorded, on an after-tax basis, as direct equity adjustments to the equity balances of the businesses. The direct equity adjustments modify the earnings available to each of the classes of common stock for earnings per share purposes.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

9. EARNINGS PER SHARE (continued)

Common Stock

A reconciliation of the numerators and denominators of the basic and diluted per share computations is as follows:

	Three Months Ended September 30,
	2003					2002
	Income (in millions)		Weighted Average Shares	Per Share Amount		Income (in millions)		Weighted Average Shares	Per Share Amount
Basic earnings per share
Income from continuing operations attributable to the Financial Services Businesses	$	256				$	378
Direct equity adjustment		19					9

Income from continuing operations attributable to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment	$	275	541,476,159	$	0.50	$	387	575,107,885	$	0.67

Effect of dilutive securities and compensation programs
Stock options			1,637,739					630,885
Deferred and long-term stock-based compensation programs			1,578,582					1,050,397
Put options			—					2,936
Equity security units			1,171,514					—

Diluted earnings per share
Income from continuing operations attributable to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment	$	275	545,863,994	$	0.50	$	387	576,792,103	$	0.67

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

9. EARNINGS PER SHARE (continued)

	Nine Months Ended September 30,
	2003					2002
	Income (in millions)		Weighted Average Shares	Per Share Amount		Income (in millions)		Weighted Average Shares	Per Share Amount
Basic earnings per share
Income from continuing operations attributable to the Financial Services Businesses	$	587				$	742
Direct equity adjustment		45					30

Income from continuing operations attributable to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment	$	632	547,670,010	$	1.15	$	772	581,082,389	$	1.33

Effect of dilutive securities and compensation programs
Stock options			1,048,353					849,350
Deferred and long-term stock-based compensation programs			1,433,636					413,491
Put options			—					979
Equity security units			390,505					—


Diluted earnings per share
Income from continuing operations attributable to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment	$	632	550,542,504	$	1.15	$	772	582,346,209	$	1.33

The Company’s equity security units include, as a component, purchase contracts requiring the holders to purchase shares of Common Stock on November 15, 2004. The purchase contracts are considered in the diluted earnings per share calculation using the treasury stock method. The purchase contracts are dilutive to earnings per share when the average market price of the Common Stock for a particular period is above $34.10.

For the three months ended September 30, 2003 and 2002, 6,630,424 and 9,280,327 options, respectively, weighted for the portion of the period they were outstanding, with weighted average exercise prices of $29.91 and $33.39 per share, respectively, were excluded from the computation of diluted earnings per share because the options, based on application of the treasury stock method, were antidilutive. For the nine months ended September 30, 2003 and 2002, 12,336,495 and 4,001,758 options, respectively, weighted for the portion of the period they were outstanding, with weighted average exercise prices of $31.63 and $32.66 per share, respectively, were excluded from the computation of diluted earnings per share because the options, based on application of the treasury stock method, were antidilutive.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

Class B Stock

Net income (loss) per share of Class B Stock was $77 million and $(90) million for the three months ended September 30, 2003 and 2002, respectively, and $145 million and $(363) million for the nine months ended September 30, 2003 and 2002, respectively. The net income (loss) attributable to the Closed Block Business available to holders of Class B Stock after direct equity adjustment for the three months ended September 30, 2003 and 2002 amounted to $58 million and $(99) million, respectively. For the three months ended September 30, 2003, the direct equity adjustment resulted in a decrease of $19 million in the net income attributable to the Closed Block Business applicable to holders of Class B Stock for earnings per share purposes. For the three months ended September 30, 2002, the direct equity adjustment resulted in an increase of $9 million in the net loss attributable to the Closed Block Business applicable to holders of Class B Stock for earnings per share purposes. The net income (loss) attributable to the Closed Block Business available to holders of Class B Stock after direct equity adjustment for the nine months ended September 30, 2003 and 2002, amounted to $100 million and $(393) million, respectively. For the nine months ended September 30, 2003, the direct equity adjustment resulted in a decrease of $45 million in the net income attributable to the Closed Block Business applicable to holders of Class B Stock for earnings per share purposes. For the nine months ended September 30, 2002, the direct equity adjustment resulted in an increase of $30 million in the net loss attributable to the Closed Block Business applicable to holders of Class B Stock for earnings per share purposes. For the three and nine months ended September 30, 2003 and 2002, the weighted average number of shares of Class B Stock used in the calculation of basic earnings per share amounted to 2,000,000 shares. There are no potentially dilutive shares associated with the Class B Stock.

10. STOCK-BASED COMPENSATION

Prior to 2003, the Company accounted for employee stock options using the intrinsic value method of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under this method, the Company did not recognize any stock-based compensation expense for employee stock options as all options granted had an exercise price equal to the market value of the underlying Common Stock on the date of grant. Effective January 1, 2003, the Company changed its accounting for employee stock options to adopt the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended, prospectively for all new awards granted to employees on or after January 1, 2003. Generally, awards under the Company’s stock option plan vest over three years. The expense related to employee stock options included in the determination of net income for 2003 is less than that which would have been recognized if the fair value method had been applied to all awards since the inception of the Company’s stock option plan. For the three and nine months ended September 30, 2003, the compensation expense recognized for employee stock options was $6 million and $13 million, net of taxes, respectively. If the Company had accounted for all employee stock options under the fair value based accounting method of SFAS No. 123, net income and earnings per share would have been as follows:

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

10. STOCK-BASED COMPENSATION (continued)

	Three Months Ended September 30, 2003				Three Months Ended September 30, 2002
	Financial Services Businesses		Closed Block Business		Financial Services Businesses		Closed Block Business
	(in millions, except per share amounts)
Net income (loss)
As reported	$	220	$	77	$	392	$	(90	)
Pro forma additional compensation expense determined under fair value method, net of taxes		9		—		10		—

Pro forma	$	211	$	77	$	382	$	(90	)

Basic and diluted net income (loss) per share
As reported	$	0.44	$	29.00	$	0.70	$	(49.50	)
Pro forma additional compensation expense determined under fair value method, net of taxes		0.02		—		0.02		—

Pro forma	$	0.42	$	29.00	$	0.68	$	(49.50	)

	Nine Months Ended September 30, 2003				Nine Months Ended September 30, 2002
	Financial Services Businesses		Closed Block Business		Financial Services Businesses		Closed Block Business
	(in millions, except per share amounts)
Net income (loss)
As reported	$	544	$	145	$	750	$	(363	)
Pro forma additional compensation expense determined under fair value method, net of taxes		30		—		21		—

Pro forma	$	514	$	145	$	729	$	(363	)

Basic and diluted net income (loss) per share
As reported	$	1.07	$	50.00	$	1.34	$	(196.50	)
Pro forma additional compensation expense determined under fair value method, net of taxes		0.05		—		0.04		—

Pro forma	$	1.02	$	50.00	$	1.30	$	(196.50	)

The Company has made two types of grants of stock options since the implementation of its stock option plan. The grants include the Associates Grant, a one-time broad based award made in December 2001, and general grants to executives (the “Executive Grants”). The Executive Grants replace a portion of long-term cash compensation, which cash compensation would have been expensed. The above table reflects the pro forma effect of the fair value based accounting method considering both the Associates Grant and the Executive Grants. The pro forma effect of the Executive Grants, without considering the Associates Grant, would have been to reduce net income by $7 million and $6 million, or $0.01 per share of Common Stock, for the three months ended September 30, 2003 and 2002, respectively, and $20 million, or $0.04 per share of Common Stock, and $7 million, or $0.01 per share of Common Stock, for the nine months ended September 30, 2003 and 2002, respectively.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION

Segments

The Company has organized its principal operations into the Financial Services Businesses and the Closed Block Business. Within the Financial Services Businesses, the Company operates through three divisions, which together encompass eight reportable segments. Businesses that are not sufficiently material to warrant separate disclosure and businesses to be divested are included in Corporate and Other operations. Collectively, the businesses that comprise the three operating divisions and Corporate and Other are referred to as the Financial Services Businesses. The segments within the Financial Services Businesses, as well as the Closed Block Business, correspond to businesses for which discrete financial information is available and reviewed by management.

In the second quarter of 2003, the Company announced its agreements to sell its National and New Jersey property and casualty insurance businesses and decided to exit certain operations of two Japanese asset management units. As a result of the Company’s decision to exit these operations, the operating results for these businesses have been classified as divested businesses for all periods presented. The National and New Jersey property and casualty insurance businesses were previously reported as part of the Insurance division while the results of the two Japanese asset management units were previously included in the International Investments segment.

On July 1, 2003, the Company completed the combination of its retail securities brokerage and clearing operations with those of Wachovia into a new joint venture as discussed in Note 6. Effective July 1, 2003, the Company is accounting for its 38% ownership of the joint venture under the equity method of accounting, and its results are reflected in the Financial Advisory segment. Periods prior to July 1, 2003, continue to reflect the results of our independent securities brokerage operations on a fully consolidated basis in the Financial Advisory segment. In addition, in the third quarter of 2003 the Company decided to exit the consumer banking business; therefore, the results of the consumer banking operations previously included within the Financial Advisory segment are shown as discontinued operations for all periods presented. The Company also sold its specialty automobile insurance business, a component of its property and casualty insurance business, on August 1, 2003 and has reflected this business as a discontinued operation for all periods presented.

Adjusted Operating Income

In managing the Financial Services Businesses, the Company analyzes the operating performance of each segment using “adjusted operating income,” which is a non-GAAP measure. Adjusted operating income is calculated by adjusting income from continuing operations before income taxes to exclude certain items. The items excluded are realized investment gains, net of losses, and related charges and adjustments (as discussed further below); and the contribution to income/loss of businesses that have been or will be divested that do not qualify for “discontinued operations” accounting treatment under GAAP.

The excluded items are important to an understanding of overall results of operations. Adjusted operating income is not a substitute for net income determined in accordance with GAAP, and the Company’s definition of adjusted operating income may differ from that used by other companies. However, the Company believes that the presentation of adjusted operating income as measured for management purposes enhances the understanding of results of operations by highlighting the results from ongoing operations and the underlying profitability factors of the Financial Services Businesses.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION (continued)

Adjusted operating income excludes net realized investment gains and losses. A significant element of realized losses is impairments and losses from sales of credit-impaired securities, the timing of which depends largely on market credit cycles and can vary considerably across periods. The timing of other sales that would result in gains or losses is largely subject to the Company’s discretion and influenced by market opportunities. Trends in the underlying profitability of the Company’s businesses can be more clearly identified without the fluctuating effects of these transactions. Adjusted operating income also excludes the results of divested businesses, which are not indicative of the Company’s future operating results.

The related charges, which offset against net realized investment gains and losses, relate to policyholder dividends, amortization of deferred policy acquisition costs, and reserves for future policy benefits. The related charges associated with policyholder dividends include a percentage of net realized investment gains on specified Gibraltar Life assets that is required to be paid as dividends to Gibraltar Life policyholders. Deferred policy acquisition costs for certain investment-type products are amortized based on estimated gross profits, which include net realized investment gains and losses on the underlying invested assets, and the related charge for amortization of deferred policy acquisition costs represents the portion of this amortization associated with net realized investment gains and losses. The reserves for certain policies are adjusted when cash flows related to these policies are affected by net realized investment gains and losses, and the related charge for reserves for future policy benefits represents that adjustment.

Gains and losses pertaining to derivatives contracts that do not qualify for hedge accounting treatment, other than derivatives used for trading purposes, are included in “Realized investment gains (losses), net.” This includes mark-to-market adjustments of open contracts as well as periodic settlements. As discussed further below, adjusted operating income includes a portion of realized gains and losses pertaining to certain derivative contracts.

Adjusted operating income of the International Insurance segment reflects the impact of an intercompany arrangement with Corporate and Other operations pursuant to which the segment’s results for a particular year, including its interim reporting periods, are translated at fixed currency exchange rates. The fixed rates are determined in connection with a currency hedging program designed to mitigate the risk that unfavorable rate changes will reduce the segment’s U.S. dollar equivalent earnings. Pursuant to this program, the Company executes forward sale contracts in the hedged currency in exchange for U.S. dollars at a specified exchange rate. The maturities of these contracts correspond with the future periods in which the non-U.S. earnings are expected to be generated. These contracts do not qualify for hedge accounting under GAAP and, as noted above, all resulting profits or losses from such contracts are included in “Realized investment gains (losses), net.” When the contracts are terminated in the same period that the expected earnings emerge, the resulting positive or negative cash flow effect is included in adjusted operating income (losses of $12 million and revenues of $5 million for the three months ended September 30, 2003 and 2002, respectively, and losses of $33 million and revenues of $42 million for the nine months ended September 30, 2003 and 2002, respectively). As of September 30, 2003, the fair value of open contracts used for this purpose was a net liability of $110 million.

The Company utilizes interest and currency swaps to manage interest and currency exchange rate exposures arising from mismatches between assets and liabilities, including duration mismatches. For the swap contracts that do not qualify for hedge accounting treatment, mark-to-market adjustments of open contracts as well as periodic settlements are included in “Realized investment gains (losses), net.” However, the periodic settlements are included in adjusted operating income. Adjusted operating income includes revenues of $15 million and

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION (continued)

$18 million in the three months ended September 30, 2003 and 2002, respectively, and revenues of $41 million and $38 million for the nine months ended September 30, 2003 and 2002, respectively, of periodic settlements of such contracts.

The Other Asset Management segment uses hedging instruments to mitigate the risk that operating results will fluctuate due to changes in estimated fair value of mortgages held for sale, commitments to lend and loan applications received. Changes in estimated fair value of such instruments are included on a current basis in “Commissions and other income.” Commencing in the fourth quarter of 2002, the Company applied hedge accounting treatment to the mortgage loan inventory. Consequently, changes in the fair value of such inventory are included on a current basis in “Commissions and other income” of the Other Asset Management segment, consistent with the related hedges. Prior to the fourth quarter of 2002, the mortgage loan inventory was recorded at the lower of aggregate cost or fair value. However, for segment reporting, changes in estimated fair value of mortgage loans (gains of $8 million and losses of $5 million for the three and nine months ended September 30, 2002) were included in adjusted operating income of the Other Asset Management segment with an offsetting adjustment to adjusted operating income of Corporate and Other operations.

The summary below reconciles adjusted operating income, a non-GAAP measure, to income from continuing operations before income taxes:

	Three Months Ended September 30, 2003
	Adjusted Operating Income		Reconciling Items									Income from Continuing Operations Before Income Taxes
	Adjusted Operating Income		Realized Investment Gains (Losses), Net, and Related Adjustments			Charges Related to Realized Gains (Losses), Net			Divested Businesses			Income from Continuing Operations Before Income Taxes
	(in millions)
Individual Life and Annuities	$	153	$	(7	)	$	(5	)	$	—		$	141
Group Insurance		30		(2	)		—			—			28

Total Insurance Division		183		(9	)		(5	)		—			169

Investment Management		36		1			—			—			37
Financial Advisory		2		—			—			—			2
Retirement		39		42			—			—			81
Other Asset Management		6		—			—			—			6

Total Investment Division		83		43			—			—			126

International Insurance		215		16			(1	)		—			230
International Investments		8		—			—			—			8

Total International Insurance and Investments Division		223		16			(1	)		—			238

Corporate and Other		32		(90	)		—			(20	)		(78	)

Total Financial Services Businesses	$	521	$	(40	)	$	(6	)	$	(20	)		455

Closed Block Business													120

Total												$	575

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION (continued)

	Three Months Ended September 30, 2002
	Adjusted Operating Income			Reconciling Items									Income from Continuing Operations Before Income Taxes
	Adjusted Operating Income			Realized Investment Gains (Losses), Net, and Related Adjustments			Charges Related to Realized Gains (Losses), Net			Divested Businesses			Income from Continuing Operations Before Income Taxes
	(in millions)
Individual Life and Annuities	$	46		$	(51	)	$	4		$	—		$	(1	)
Group Insurance		30			(37	)		—			—			(7	)

Total Insurance Division		76			(88	)		4			—			(8	)

Investment Management		29			1			—			—			30
Financial Advisory		(15	)		—			—			—			(15	)
Retirement		24			(99	)		(2	)		—			(77	)
Other Asset Management		13			—			—			—			13

Total Investment Division		51			(98	)		(2	)		—			(49	)

International Insurance		186			(27	)		(3	)		—			156
International Investments		2			—			—			—			2

Total International Insurance and Investments Division		188			(27	)		(3	)		—			158

Corporate and Other		112			71			—			(13	)		170

Total Financial Services Businesses	$	427		$	(142	)	$	(1	)	$	(13	)		271

Closed Block Business														(142	)

Total													$	129

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION (continued)

	Nine Months Ended September 30, 2003
	Adjusted Operating Income			Reconciling Items									Income from Continuing Operations Before Income Taxes
	Adjusted Operating Income			Realized Investment Gains (Losses), Net, and Related Adjustments			Charges Related to Realized Gains (Losses), Net			Divested Businesses			Income from Continuing Operations Before Income Taxes
	(in millions)
Individual Life and Annuities	$	460		$	(37	)	$	(8	)	$	—		$	415
Group Insurance		122			(30	)		—			—			92

Total Insurance Division		582			(67	)		(8	)		—			507

Investment Management		109			4			—			—			113
Financial Advisory		(44	)		—			—			—			(44	)
Retirement		137			18			6			—			161
Other Asset Management		31			—			—			—			31

Total Investment Division		233			22			6			—			261

International Insurance		597			(58	)		(23	)		—			516
International Investments		21			(1	)		—			—			20

Total International Insurance and Investments Division		618			(59	)		(23	)		—			536

Corporate and Other		49			(41	)		—			(419	)		(411	)

Total Financial Services Businesses	$	1,482		$	(145	)	$	(25	)	$	(419	)		893

Closed Block Business														227

Total													$	1,120

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION (continued)

	Nine Months Ended September 30, 2002
				Reconciling Items
	Adjusted Operating Income			Realized Investment Gains (Losses), Net, and Related Adjustments			Charges Related to Realized Gains (Losses), Net			Divested Businesses		Income from Continuing Operations Before Income Taxes
	(in millions)
Individual Life and Annuities	$	305		$	(116	)	$	6		$	—	$	195
Group Insurance		103			(85	)		—			—		18

Total Insurance Division		408			(201	)		6			—		213

Investment Management		112			62			—			—		174
Financial Advisory		(14	)		—			—			—		(14	)
Retirement		108			(260	)		6			—		(146	)
Other Asset Management		41			—			—			—		41

Total Investment Division		247			(198	)		6			—		55

International Insurance		577			(138	)		(12	)		—		427
International Investments		(2	)		—			—			—		(2	)

Total International Insurance and Investments Division		575			(138	)		(12	)		—		425

Corporate and Other		161			(46	)		—			36		151

Total Financial Services Businesses	$	1,391		$	(583	)	$	—		$	36		844

Closed Block Business													(571	)

Total												$	273

The Individual Life and Annuities segment results reflect deferred policy acquisition costs as if the individual annuity business were a stand-alone operation. The elimination of intersegment costs capitalized in accordance with this policy is included in consolidating adjustments within Corporate and Other operations.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

11. SEGMENT INFORMATION (continued)

The summary below presents revenues for the Company’s reportable segments:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
	(in millions)
Individual Life and Annuities	$	796		$	679		$	2,231		$	1,952
Group Insurance		882			882			2,753			2,671

Total Insurance Division		1,678			1,561			4,984			4,623

Investment Management		323			293			911			926
Financial Advisory		122			586			1,217			1,867
Retirement		550			575			1,696			1,756
Other Asset Management		19			24			70			74

Total Investment Division		1,014			1,478			3,894			4,623

International Insurance		1,419			1,287			4,173			3,784
International Investments		102			83			289			244

Total International Insurance and Investments Division		1,521			1,370			4,462			4,028

Corporate and Other		156			127			344			314

Total		4,369			4,536			13,684			13,588

Items excluded from adjusted operating income:
Realized investment losses, net, and related adjustments		(40	)		(142	)		(145	)		(583	)
Divested businesses		475			469			1,417			1,418

Total Financial Services Businesses		4,804			4,863			14,956			14,423

Closed Block Business		1,900			1,734			5,859			5,337

Total per Consolidated Financial Statements	$	6,704		$	6,597		$	20,815		$	19,760

The Investment Management segment revenues include intersegment revenues of $79 million and $94 million for the three months ended September 30, 2003 and 2002, respectively, and $269 million and $291 million for the nine months ended September 30, 2003 and 2002, respectively, primarily consisting of asset-based management and administration fees. In addition, the Financial Advisory segment revenues include intersegment revenues of $4 million and $49 million for the three months ended September 30, 2003 and 2002, respectively, and $86 million and $151 million for the nine months ended September 30, 2003 and 2002, respectively, relating to the sale of proprietary investments products. Management has determined the intersegment revenues with reference to market rates. Intersegment revenues are eliminated in consolidation.

12. CONTINGENCIES AND LITIGATION

Contingencies

On September 19, 2000, the Company sold Gibraltar Casualty Company (“Gibraltar Casualty”), a subsidiary engaged in the commercial property and casualty insurance business, to Everest Re Group, Ltd. (“Everest”). Upon closing of the sale, the Company entered into a stop-loss reinsurance agreement with Everest whereby the Company will reinsure Everest for up to 80% of the first $200 million of any adverse loss development in excess

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

12. CONTINGENCIES AND LITIGATION (continued)

of Gibraltar Casualty’s carried reserves as of the closing of the sale. Through September 30, 2003, Everest had recorded reserve additions of $132 million and the Company has recorded a liability of $106 million, representing its share of such development.

In September of 2003, Prudential Financial confirmed that it had received formal requests for information from regulators, including the Securities and Exchange Commission, the NASD, the State of New York Attorney General’s Office and the Securities Division of the Massachusetts Secretary of the Commonwealth (the “MSD”), in connection with issues relating to the purchase and sale of mutual fund shares. Recently, the Company received a request for information from the New York Stock Exchange in connection with the above matters and an additional formal request from the New York Attorney General’s Office in connection with its variable annuity business. The Company is cooperating with all such inquiries and is conducting its own internal review. On November 4, 2003, the MSD filed an administrative complaint against three former brokers and two former branch managers of Prudential Securities, Inc. (“PSI”) alleging violations of securities laws. On that date the Securities and Exchange Commission filed a similar civil action against five former brokers and one former branch manager of PSI in Massachusetts federal court. The Company is not a party to these actions. These matters could result in modifications of our internal supervisory and control functions and could lead to regulatory proceedings that result in fines or other sanctions. In addition, the Company may become subject to civil litigation. Because of the complexity and scope of the internal review and the uncertainties of potential regulatory proceedings and civil litigation, the Company is unable to estimate its potential exposure, if any, at this time.

On an ongoing basis, our internal supervisory and control functions review the quality of our sales, marketing and other customer interface procedures and practices and may recommend modifications or enhancements. In certain cases, if appropriate, we may offer customers remediation and may incur charges, including the cost of such remediation, administrative costs and regulatory fines.

It is possible that the results of operations or the cash flow of the Company in a particular quarterly or annual period could be materially affected as a result of payments in connection with the matters discussed above depending, in part, upon the results of operations or cash flow for such period. Management believes, however, that ultimate payments in connection with these matters should not have a material adverse effect on the Company’s financial position.

Litigation

The Company is subject to legal and regulatory actions in the ordinary course of its businesses. Pending legal and regulatory actions include proceedings relating to aspects of our businesses and operations that are specific to the Company and proceedings that are typical of the businesses in which the Company operates, including in both cases businesses that have either been divested or placed in wind-down status. Some of these proceedings have been brought on behalf of various alleged classes of complainants. In certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages.

In July 2003, in Burns, et al. v. Prudential Securities, Inc. et al., the Marion County, Ohio Court of Common Pleas denied PSI’s motion to set aside or reduce the jury verdict, for $269.2 million including $250 million in punitive damages, and sustained the judgment previously entered against PSI. PSI has appealed.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Consolidated Financial Statements

12. CONTINGENCIES AND LITIGATION (continued)

In August 2003, the Ninth Circuit Court of Appeals issued an en banc opinion in LaPine Technology Corp. v. Kyocera Corp. vacating the Court’s earlier decisions and reinstating the District Court’s 1995 affirmance of the arbitration award favorable to PSI.

On November 6, 2003, an action was commenced in the United States Bankruptcy Court for the Southern District of New York, Enron Corp. v. J.P. Morgan Securities, Inc., et al., against approximately 100 defendants, including Prudential Insurance and other Prudential entities, who invested in Enron’s commercial paper. The complaint alleges that Enron’s October 2001 prepayment of its commercial paper is a voidable preference under the bankruptcy laws and constitutes a fraudulent conveyance. The complaint alleges that the Company received prepayments of approximately $100 million.

The Company’s litigation is subject to many uncertainties, and given its complexity and scope, the outcomes cannot be predicted. It is possible that the results of operations or the cash flow of the Company in a particular quarterly or annual period could be materially affected by an ultimate unfavorable resolution of pending litigation and regulatory matters depending, in part, upon the results of operations or cash flow for such period. Management believes, however, that the ultimate outcome of all pending litigation and regulatory matters, after consideration of applicable reserves, should not have a material adverse effect on the Company’s financial position.

See “Part II—Other Information—Item 1. Legal Proceedings” for a discussion of other events related to litigation involving the Company.

13. SUBSEQUENT EVENT

On November 11, 2003, the Company declared annual dividends for 2003 of $0.50 per share of Common Stock and $9.625 per share of Class B Stock, each payable on December 18, 2003, to shareholders of record as of November 25, 2003.

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM SUPPLEMENTAL COMBINING STATEMENTS OF FINANCIAL POSITION

SEPTEMBER 30, 2003 AND DECEMBER 31, 2002 (in millions)

	September 30, 2003						December 31, 2002
	Financial Services Businesses		Closed Block Business		Consolidated		Financial Services Businesses		Closed Block Business		Consolidated
ASSETS
Fixed maturities:
Available for sale, at fair value	$	84,725	$	47,647	$	132,372	$	79,230	$	46,233	$	125,463
Held to maturity, at amortized cost		2,954		—		2,954		2,612		—		2,612
Trading account assets, at fair value		3,852		—		3,852		3,449		—		3,449
Equity securities, available for sale, at fair value		1,106		2,075		3,181		1,286		1,521		2,807
Commercial loans		12,100		7,031		19,131		12,300		6,987		19,287
Policy loans		2,732		5,556		8,288		3,146		5,681		8,827
Securities purchased under agreements to resell		1,276		—		1,276		4,844		—		4,844
Cash collateral for borrowed securities		—		—		—		4,978		—		4,978
Other long-term investments		5,840		1,081		6,921		4,333		1,075		5,408
Short-term investments		3,758		3,903		7,661		2,840		2,579		5,419

Total investments		118,343		67,293		185,636		119,018		64,076		183,094
Cash and cash equivalents		6,252		2,390		8,642		7,470		2,428		9,898
Accrued investment income		1,139		806		1,945		1,021		769		1,790
Broker-dealer related receivables		908		—		908		5,631		—		5,631
Deferred policy acquisition costs		6,348		1,179		7,527		5,875		1,156		7,031
Other assets		14,285		4,987		19,272		13,730		1,017		14,747
Separate account assets		101,841		—		101,841		70,555		—		70,555

TOTAL ASSETS	$	249,116	$	76,655	$	325,771	$	223,300	$	69,446	$	292,746

LIABILITIES AND ATTRIBUTED EQUITY LIABILITIES
Future policy benefits	$	44,608	$	48,567	$	93,175	$	42,213	$	48,247	$	90,460
Policyholders’ account balances		42,766		5,503		48,269		40,799		5,481		46,280
Unpaid claims and claim adjustment expenses		3,201		—		3,201		3,428		—		3,428
Policyholders’ dividends		1,000		3,920		4,920		918		2,757		3,675
Securities sold under agreements to repurchase		5,454		4,559		10,013		10,250		4,652		14,902
Cash collateral for loaned securities		3,563		2,409		5,972		7,517		2,714		10,231
Income taxes payable		2,019		12		2,031		1,910		23		1,933
Broker-dealer related payables		1,951		—		1,951		4,838		—		4,838
Securities sold but not yet purchased		1,620		—		1,620		1,996		—		1,996
Short-term debt		5,117		—		5,117		3,469		—		3,469
Long-term debt		4,330		1,750		6,080		3,007		1,750		4,757
Other liabilities		11,105		8,985		20,090		11,148		3,054		14,202
Separate account liabilities		101,841		—		101,841		70,555		—		70,555

Total liabilities		228,575		75,705		304,280		202,048		68,678		270,726

Guaranteed beneficial interest in Trust holding solely debentures of Parent		—		—		—		690		—		690

COMMITMENTS AND CONTINGENCIES ATTRIBUTED EQUITY
Accumulated other comprehensive income		1,977		728		2,705		1,941		644		2,585
Other attributed equity		18,564		222		18,786		18,621		124		18,745

Total attributed equity		20,541		950		21,491		20,562		768		21,330

TOTAL LIABILITIES AND ATTRIBUTED EQUITY	$	249,116		76,655	$	325,771	$	223,300	$	69,446	$	292,746

See Notes to Unaudited Interim Supplemental Combining Financial Information

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

(in millions)

	2003								2002
	Financial Services Businesses			Closed Block Business		Consolidated			Financial Services Businesses			Closed Block Business			Consolidated
REVENUES
Premiums	$	2,433		$	878	$	3,311		$	2,320		$	912		$	3,232
Policy charges and fee income		475			—		475			400			—			400
Net investment income		1,266			892		2,158			1,304			928			2,232
Realized investment gains (losses), net		(37	)		119		82			(119	)		(126	)		(245	)
Commissions and other income		667			11		678			958			20			978

Total revenues		4,804			1,900		6,704			4,863			1,734			6,597

BENEFITS AND EXPENSES
Policyholders’ benefits		2,332			935		3,267			2,250			963			3,213
Interest credited to policyholders’ account balances		424			35		459			434			34			468
Dividends to policyholders		30			607		637			33			655			688
General and administrative expenses		1,529			203		1,732			1,875			224			2,099
Loss on disposition of property and casualty insurance operations		34			—		34			—			—			—

Total benefits and expenses		4,349			1,780		6,129			4,592			1,876			6,468

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		455			120		575			271			(142	)		129

Income tax expense (benefit)		199			43		242			(107	)		(52	)		(159	)

INCOME (LOSS) FROM CONTINUING OPERATIONS		256			77		333			378			(90	)		288
Income (loss) from discontinued operations, net of taxes		(36	)		—		(36	)		14			—			14

NET INCOME (LOSS)	$	220		$	77	$	297		$	392		$	(90	)	$	302

See Notes to Unaudited Interim Supplemental Combining Financial Information

PRUDENTIAL FINANCIAL, INC.

UNAUDITED INTERIM SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

(in millions)

	2003								2002
	Financial Services Businesses			Closed Block Business		Consolidated			Financial Services Businesses			Closed Block Business			Consolidated
REVENUES
Premiums	$	7,338		$	2,814	$	10,152		$	6,798		$	2,940		$	9,738
Policy charges and fee income		1,342			—		1,342			1,246			—			1,246
Net investment income		3,821			2,720		6,541			3,889			2,721			6,610
Realized investment gains (losses), net		(137	)		274		137			(503	)		(382	)		(885	)
Commissions and other income		2,592			51		2,643			2,993			58			3,051

Total revenues		14,956			5,859		20,815			14,423			5,337			19,760

BENEFITS AND EXPENSES
Policyholders’ benefits		7,029			3,056		10,085			6,606			3,152			9,758
Interest credited to policyholders’ account balances		1,263			103		1,366			1,263			102			1,365
Dividends to policyholders		113			1,830		1,943			106			1,946			2,052
General and administrative expenses		5,169			643		5,812			5,604			708			6,312
Loss on disposition of property and casualty insurance operations		489			—		489			—			—			—

Total benefits and expenses		14,063			5,632		19,695			13,579			5,908			19,487

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		893			227		1,120			844			(571	)		273

Income tax expense (benefit)		306			82		388			102			(208	)		(106	)

INCOME (LOSS) FROM CONTINUING OPERATIONS		587			145		732			742			(363	)		379
Loss from discontinued operations, net of taxes		(43	)		—		(43	)		8			—			8

NET INCOME (LOSS)	$	544		$	145	$	689		$	750		$	(363	)	$	387

See Notes to Unaudited Interim Supplemental Combining Financial Information

PRUDENTIAL FINANCIAL, INC.

Notes to Unaudited Interim Supplemental Combining Financial Information

1. BASIS OF PRESENTATION

The supplemental combining financial information presents the consolidated financial position and results of operations for Prudential Financial, Inc. and its subsidiaries (the “Company”) separately reporting the Financial Services Businesses and the Closed Block Business. The Financial Services Businesses and the Closed Block Business are both fully integrated operations of the Company and are not separate legal entities. The supplemental combining financial information presents the results of the Financial Services Businesses and the Closed Block Business as if they were separate reporting entities and should be read in conjunction with the Unaudited Interim Consolidated Financial Statements.

The Company has outstanding two classes of common stock. The Common Stock reflects the performance of the Financial Services Businesses and the Class B Stock reflects the performance of the Closed Block Business.

The Closed Block Business was established on the date of demutualization and includes the assets and liabilities of the Closed Block (see Note 6, to the Unaudited Interim Consolidated Financial Statements for a description of the Closed Block). It also includes assets held outside the Closed Block necessary to meet insurance regulatory capital requirements related to products included within the Closed Block; deferred policy acquisition costs related to the Closed Block policies; the principal amount of the IHC debt (see Note 2 below) and related unamortized debt issuance costs and an interest rate swap related to the IHC debt; and certain other related assets and liabilities. The Financial Services Businesses consist of the Insurance, Investment, and International Insurance and Investments divisions and Corporate and Other operations.

2. ALLOCATION OF RESULTS

This supplemental combining financial information reflects the assets, liabilities, revenues and expenses directly attributable to the Financial Services Businesses and the Closed Block Business, as well as allocations deemed reasonable by management in order to fairly present the financial position and results of operations of each business on a stand alone basis. While management considers the allocations utilized to be reasonable, management has the discretion to make operational and financial decisions that may affect the allocation methods and resulting assets, liabilities, revenues and expenses of each business. In addition, management has limited discretion over accounting policies and the appropriate allocation of earnings between the two businesses. The Company has agreements which provide that, in most instances, the Company may not change the allocation methodology or accounting policies for the allocation of earnings between the Financial Services Businesses and Closed Block Business without the prior consent of the Class B Stock investors or IHC debt bond insurer.

General corporate overhead not directly attributable to a specific business that has been incurred in connection with the generation of the businesses’ revenues is generally allocated based on the historical general and administrative expenses of each business as a percentage of the total for the Company.

Prudential Holdings, LLC, a wholly owned subsidiary of Prudential Financial, Inc., has outstanding senior secured notes (the “IHC debt”), of which net proceeds of $1.66 billion were allocated to the Financial Services Businesses concurrent with Prudential Insurance’s demutualization on December 18, 2001. The IHC debt is serviced by the cash flows of the Closed Block Business, and the results of the Closed Block Business reflect interest expense associated with the IHC debt.

PRUDENTIAL FINANCIAL, INC.

Notes To Unaudited Interim Supplemental Combining Financial Information

2. ALLOCATION OF RESULTS (continued)

Income taxes are allocated between the Financial Services Businesses and the Closed Block Business as if they were separate companies based on the taxable income or losses and other tax characterizations of each business. If a business generates benefits, such as net operating losses, it is entitled to record such tax benefits to the extent they are expected to be utilized on a consolidated basis.

Holders of Common Stock have no interest in a legal entity representing the Financial Services Businesses; holders of the Class B Stock have no interest in a legal entity representing the Closed Block Business and holders of each class of common stock are subject to all of the risks associated with an investment in the Company.

In the event of a liquidation, dissolution or winding-up of the Company, holders of Common Stock and holders of Class B Stock would be entitled to receive a proportionate share of the net assets of the Company that remain after paying all liabilities and the liquidation preferences of any preferred stock.

The results of the Financial Services Businesses are subject to certain risks pertaining to the Closed Block. These include any expenses and liabilities from litigation affecting the Closed Block policies as well as the consequences of certain potential adverse tax determinations. In connection with the sale of the Class B Stock and IHC debt, the cost of indemnifying the investors with respect to certain matters will be borne by the Financial Services Businesses.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the consolidated financial condition of Prudential Financial at September 30, 2003, compared with December 31, 2002, and its consolidated results of operations for the three and nine months ended September 30, 2003, and September 30, 2002. You should read the following analysis of our consolidated financial condition and results of operations in conjunction with the Company’s MD&A and audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, and Unaudited Interim Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.

Overview

Demutualization and Related Transactions

On the date of demutualization, Prudential Insurance converted from a mutual life insurance company owned by its policyholders to a stock life insurance company and became an indirect, wholly owned subsidiary of Prudential Financial. On that date, eligible policyholders, as defined in the Plan of Reorganization, received shares of Prudential Financial’s Common Stock or the right to receive cash or policy credits, which are increases in policy values or increases in other policy benefits, upon the extinguishment of all membership interests in Prudential Insurance.

The Company has two classes of common stock outstanding. The Common Stock reflects the performance of the Financial Services Businesses and the Class B Stock reflects the performance of the Closed Block Business, discussed below.

Financial Services Businesses and Closed Block Business

Financial Services Businesses

We refer to the businesses in our three operating divisions and our Corporate and Other operations, collectively, as our Financial Services Businesses. The Insurance division consists of our Individual Life and Annuities and Group Insurance segments. The Investment division consists of our Investment Management, Financial Advisory, Retirement, and Other Asset Management segments. The Financial Advisory segment includes the results of our equity method investment in Wachovia Securities, LLC commencing July 1, 2003, when our retail securities brokerage operations were combined with Wachovia, and our independent retail securities brokerage operations for periods ended prior to that date. The International Insurance and Investments division consists of our International Insurance and International Investments segments. We also have Corporate and Other operations, which includes our real estate and relocation services business, as well as corporate items and initiatives that are not allocated to business segments. Corporate and Other operations also include businesses that have been or will be divested, including our property and casualty insurance operations other than our specialty automobile insurance business that was accounted for as a discontinued operation, and businesses that we have placed in wind-down status.

We attribute financing costs to each segment based on the amount of financing used by each segment. The net investment income of each segment includes earnings on the amount of equity that management believes is necessary to support the risks of that segment.

We seek growth internally and through acquisition, joint ventures or other forms of business combination or investment. Our principal acquisition focus is in our current business lines, both domestic and international.

Closed Block Business

In connection with the demutualization, we ceased offering domestic participating products. The liabilities for our individual in force participating products were segregated, together with assets, in a regulatory mechanism referred to as the “Closed Block.” The Closed Block is designed generally to provide for the reasonable expectations for future policy dividends after demutualization of holders of policies included in the Closed Block by allocating assets that will be used exclusively for payment of benefits, including policyholder dividends, expenses and taxes with respect to these products. See Note 7 to the Unaudited Interim Consolidated Financial Statements for more information on the Closed Block. We selected the amount and type of Closed Block assets and Closed Block liabilities included in the Closed Block so that the Closed Block assets initially had a lower book value than the Closed Block liabilities. We expect that the Closed Block assets will generate sufficient cash flow, together with anticipated revenues from the Closed Block policies, over the life of the Closed Block to fund payments of all expenses, taxes, and policyholder benefits to be paid to, and the reasonable dividend expectations of, policyholders of the Closed Block policies. We also segregated for accounting purposes the assets that we need to hold outside the Closed Block to meet capital requirements related to the policies included within the Closed Block. No policies sold after demutualization will be added to the Closed Block, and its in force business is expected to ultimately decline as we pay policyholder benefits in full. We also expect the proportion of our business represented by the Closed Block to decline as we grow other businesses.

The Closed Block Business consists principally of the Closed Block, assets held outside the Closed Block that Prudential Insurance needs to hold to meet capital requirements related to the Closed Block policies, invested assets held outside the Closed Block that represent the difference between the Closed Block assets and Closed Block liabilities and the interest maintenance reserve, deferred policy acquisition costs related to Closed Block policies, the principal amount of the IHC debt and related hedging activities and certain other related assets and liabilities. The net proceeds from the issuances of the Class B Stock and IHC debt issued at the time of our demutualization, except for $72 million used to purchase a guaranteed investment contract to fund a portion of the bond insurance cost associated with that debt, were allocated to the Financial Services Businesses. However, we expect that the IHC debt will be serviced by the net cash flows of the Closed Block Business over time, and we include interest expenses associated with the IHC debt when we report results of the Closed Block Business.

Recently Issued Accounting Pronouncements

See Note 2 to the Unaudited Interim Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

Consolidated Results of Operations

In managing our business, we analyze operating performance separately for our Financial Services Businesses and our Closed Block Business. For the Financial Services Businesses, we analyze our segments’ operating performance using a non-GAAP measure we call “adjusted operating income.” Results of the Closed Block Business for all periods are evaluated and presented only in accordance with generally accepted accounting principles (“GAAP”). We calculate adjusted operating income for the segments of the Financial Services Businesses by adjusting our income from continuing operations before income taxes to exclude the following items:

•

realized investment gains, net of losses, and related charges and adjustments; and

•

the contribution to income/loss of divested businesses that have been or will be sold or exited that do not qualify for “discontinued operations” accounting treatment under GAAP.

Wind-down businesses that we have not divested remain in adjusted operating income.

The excluded items are important to an understanding of our overall results of operations. Adjusted operating income should not be viewed as a substitute for net income determined in accordance with GAAP, and our definition of adjusted operating income may differ from that used by other companies. However, we believe that the presentation of adjusted operating income as we measure it for management purposes enhances the understanding of our results of operations by highlighting the results from ongoing operations and the underlying profitability of our businesses. Adjusted operating income excludes net realized investment gains and losses. A significant element of realized losses is impairments and losses from sales of credit-impaired securities, the timing of which depends largely on market credit cycles and can vary considerably across periods. The timing of other sales that would result in gains or losses is largely subject to our discretion and influenced by market opportunities. Trends in the underlying profitability of our businesses can be more clearly identified without the fluctuating effects of these transactions. Adjusted operating income also excludes the results of divested businesses, which are not indicative of our future operating results.

Net Income and Other Data

The following table summarizes income from continuing operations, including period over period variances, for the Financial Services Businesses and the Closed Block Business as well as other components comprising net income.

	Three Months Ended September 30,						Nine Months Ended September 30,						Favorable (Unfavorable)
	2003			2002			2003			2002			Three Month Comparison			Nine Month Comparison
	(in millions)
Financial Services Businesses:
Individual Life and Annuities	$	141		$	(1	)	$	415		$	195		$	142		$	220
Group Insurance		28			(7	)		92			18			35			74

Insurance Division		169			(8	)		507			213			177			294

Investment Management		37			30			113			174			7			(61	)
Financial Advisory		2			(15	)		(44	)		(14	)		17			(30	)
Retirement		81			(77	)		161			(146	)		158			307
Other Asset Management		6			13			31			41			(7	)		(10	)

Investment Division		126			(49	)		261			55			175			206

International Insurance		230			156			516			427			74			89
International Investments		8			2			20			(2	)		6			22

International Insurance and Investments Division		238			158			536			425			80			111

Corporate and Other		(78	)		170			(411	)		151			(248	)		(562	)

Total Financial Services Businesses		455