PRUDENTIAL ANNUITIES LIFE ASSURANCE CORP/CT – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Prudential Annuities Life Assurance Corporation meets the conditions set forth in General Instruction H(1)(a) and (b) on Form 10-Q and is therefore filing this form with the reduced disclosure format.

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the financial condition of Prudential Annuities Life Assurance Corporation ("PALAC" or the "Company"), as of June 30, 2013 compared with December 31, 2012, and its results of operations for the three and six months ended June 30, 2013 and 2012. You should read the following analysis of our financial condition and results of operations in conjunction with the audited Financial Statements, and the "Risk Factors" section included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012, the statements under "Forward Looking Statements," "Risk Factors" and the Unaudited Interim Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.

Overview

The Company was established in 1988 and has been a provider of variable annuity contracts for the individual market in the United States. The Company's products have been sold primarily to individuals to provide for long-term savings and retirement needs and to address the economic impact of premature death, estate planning concerns and supplemental retirement income.

The Company has sold a wide array of annuities, including (1) deferred and immediate variable annuities that are registered with the United States Securities and Exchange Commission (the "SEC"), including fixed interest rate allocation options, subject to a market value adjustment, and (2) fixed-rate allocation options not subject to a market value adjustment and not registered with the SEC. In addition, the Company has a relatively small inforce block of variable life insurance policies, but it no longer actively sells such policies.

Beginning in March 2010, the Company ceased offering its existing variable annuity products (and where offered, the companion market value adjustment option) to new investors upon the launch of a new product line by each of Pruco Life Insurance Company and Pruco Life Insurance Company of New Jersey (which are affiliates of the Company). These initiatives were implemented to create operational and administrative efficiencies by offering a single product line of annuity products from a more limited group of legal entities. During 2012, the Company suspended additional customer deposits for variable annuities with certain optional living benefit riders.

Revenues and Expenses

The Company earns revenues from policy charges, fee income, asset administration fees calculated on the average separate account fund balances and from net investment income on the investment of general account and other funds. The Company's operating expenses principally consist of insurance benefits provided and reserves established for anticipated future insurance benefits, general business expenses, commissions and other costs of selling and servicing the various products it sold.

Effective February 25, 2013, the Advanced Series Trust ("AST") adopted a Rule 12b-1 Plan under the Investment Company Act of 1940 with respect to most of the AST portfolios that are primarily offered through the Company's variable annuity investment options. Under the Rule 12b-1 Plan, AST pays an affiliate of the Company for distribution and administrative services. Prior to the adoption of the 12b-1 Plan, the Company received an administrative service fee from AST and incurred expenses associated with administration services provided. While we expect the level of revenue and expenses of the Company in 2013 to decline relative to 2012 due to the elimination of the administrative services fee and related expenses, we do not expect a material impact to net income related to AST's adoption of the Rule 12b-1 Plan.

Profitability

The Company's profitability depends principally on its ability to manage risk on insurance and annuity products. Profitability also depends on, among other items, our actuarial and policyholder behavior experience on insurance and annuity products, our ability to retain customer assets, generate and maintain favorable investment results, and to manage expenses. See "Risk Factors" included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for a discussion of risks that have materially affected and may affect in the future the Company's business, results of operations or financial condition, or cause the Company's actual results to differ materially from those expected or those expressed in any forward looking statements made by or on behalf of the Company.

Products

The Company's inforce variable annuities provide its customers with tax-deferred asset accumulation together with a base death benefit and a suite of optional guaranteed death and living benefits. The benefit features contractually guarantee the contractholder a return of no less than (1) total deposits made to the contract less any partial withdrawals ("return of net deposits"), (2) total deposits made to the contract less any partial withdrawals plus a minimum return ("minimum return"), and/or (3) the highest contract value on a specified date minus any withdrawals ("contract value"). These guarantees may include benefits that are payable in the event of death, annuitization or at specified dates during the accumulation period and withdrawal and income living benefits payable during specified periods. Certain optional living benefit guarantees include, among other features, the ability to make withdrawals based on the highest daily contract value plus a minimum return, credited for a period of time. This guaranteed contract value is a notional amount that forms the basis for determination of periodic withdrawals for the life of the contractholder, and cannot be accessed as a lump-sum surrender value.

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Our variable annuities provide our customers with the opportunity to allocate purchase payments to sub-accounts that invest in underlying proprietary and non-proprietary mutual funds, frequently under asset allocation programs, and fixed-rate accounts. The fixed-rate accounts are credited with interest at rates we determine, subject to certain minimums. We also offered fixed annuities that provide a guarantee of principal and interest credited at rates we determine, subject to certain contractual minimums. Certain investments made in the fixed-rate accounts of our variable annuities and certain fixed annuities impose a market value adjustment if the invested amount is not held to maturity.

The primary risk exposures of our variable annuity contracts relate to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including equity market returns, interest rates, market volatility, contractholder longevity/mortality, timing and amount of annuitization and withdrawals, withdrawal efficiency and contract lapses. The return we realize from our variable annuity contracts will vary based on the extent of the differences between our actual experience and the assumptions used in the original pricing of these products. Our returns can also vary due to the impact of affiliated reinsurance, the impact and effectiveness of our hedging programs for any capital markets movements that we may hedge, the impact of that portion of our variable annuity contracts with an asset transfer feature, the impact of risks we have retained and the impact of risks that are not able to be hedged.

Our risk management strategy helps to limit our exposure to certain of these risks primarily through a combination of product design elements, our living benefits hedging program and affiliated reinsurance arrangements. The product design elements we utilize for certain products include, among others, asset allocation restrictions, minimum issuance age requirements, certain limitations on the amount of subsequent contractholder deposits and an asset transfer feature. The objective of the asset transfer feature is to help mitigate our exposure to equity market risk and market volatility by transferring assets between certain variable investment sub-accounts selected by the annuity contractholder and investments that are expected to be more stable (e.g., a bond fund sub-account within the separate account or a fixed-rate account within the general account). The transfers are based on the static mathematical formula used with the particular optional benefit which considers a number of factors, including, but not limited to, the impact of investment performance on the contractholder's total account value. This occurs at the contractholder level, rather than at the fund level, which we believe enhances our risk mitigation. As of June 30, 2013 approximately $39.2 billion or 83% of total variable annuity account values contain a living benefit feature, compared to approximately $40.0 billion or 82% as of December 31, 2012. As of June 30, 2013 approximately $31.0 billion or 79% of variable annuity account values with living benefit features included an asset transfer feature in the product design, compared to approximately $32.0 billion or 80% as of December 31, 2012.

As mentioned above, in addition to our asset transfer feature, we also manage certain risks associated with our variable annuity products through our living benefits hedging programs and affiliated reinsurance agreements. We reinsure the majority of our variable annuity living benefit guarantees to an affiliated reinsurance company, Pruco Reinsurance, Ltd. ("Pruco Re"). The living benefits hedging program is primarily executed within Pruco Re to manage capital markets risk associated with the reinsured optional living benefit guarantees. The program is also executed within the Company related to certain non-reinsured optional living benefit guarantees. This program represents a balance among three objectives that seek to: 1) provide severe scenario protection, 2) minimize net income volatility associated with an internally-defined hedge target, and 3) maintain capital efficiency. Through the hedge program, derivatives are entered into that seek to replicate the net change in an internally-defined hedge target. In addition to mitigating capital markets risk and income statement volatility, the hedging program is also focused on a long-term goal of accumulating assets that could be used to pay claims under these benefits irrespective of market path, recognizing that, under the terms of the contracts, we do not expect to begin substantial payment of such claims until at least five years in the future.

Application of Critical Accounting Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the application of accounting policies that often involve a significant degree of judgment. Management, on an ongoing basis, reviews estimates and assumptions used in the preparation of financial statements. If management determines that modifications in assumptions and estimates are appropriate given current facts and circumstances, results of operations and financial position as reported in the Unaudited Interim Financial Statements could change significantly.

Management believes the accounting policies relating to the following areas are most dependent on the application of estimates and assumptions and require management's most difficult, subjective, or complex judgments:

   -    Deferred policy acquisition costs ("DAC") and other costs, including value of      business acquired;   -    Valuation of investments, including derivatives, and the recognition of      other-than-temporary impairments;   -   Policyholder liabilities;   -   Taxes on income; and   -    Reserves for contingencies, including reserves for losses in connection with      unresolved legal matters.  

The near-term future equity rate of return assumption used in evaluating DAC and deferred sales inducements ("DSI") is derived using a reversion to the mean approach, a common industry practice. Under this approach, we consider historical equity returns over a period of time and initially adjust future projected equity returns over the next four years (the "near-term") so that the assets are projected to grow at the long-term expected rate of return for the entire period. If the near-term projected future rate of return is greater than our near-term maximum future rate of return of 13%, we use our maximum future rate of return.

The weighted average rate of return assumptions consider many factors including asset durations, asset allocations and other factors. We update the near term equity rate of return and our estimate of total gross profits each quarter to reflect the result of the reversion to the mean approach, which assumes a convergence to the long-term equity expected rate of return. These market performance related adjustments to our estimate of total gross profits result in cumulative adjustments to prior amortization, reflecting the application of the new required rate of amortization to all prior periods' gross profits. The new required rate of amortization is also applied prospectively to future gross profits in calculating amortization in future periods. As of June 30, 2013, our variable annuities business assumes an 8.0% long-term equity expected rate of return and a near-term mean reversion equity rate of return of 6.7%.

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Additional information on our policies for our critical accounting estimates listed above may also be found in our Annual Report on Form 10-K for the year ended December 31, 2012, under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Application of Critical Accounting Estimates."

Adoption of New Accounting Pronouncements

See Note 2 to our Unaudited Interim Financial Statements for a discussion of newly adopted accounting pronouncements.

Changes in Financial Position

June 30, 2013 versus December 31, 2012

Total assets decreased by $1.7 billion, from $52.8 billion at December 31, 2012 to $51.1 billion at June 30, 2013. Reinsurance recoverables decreased $1.1 billion related to the reinsured liability for living benefit embedded derivatives primarily resulting from a decrease in the present value of future expected benefit payments driven by increases in interest rates. Total investments decreased $441 million primarily due to asset sales associated with contractholder surrenders, the impact of the asset transfer feature which moved customer account values from the general account to the separate account due to favorable markets in the first six months of 2013 and a decrease in unrealized gains on fixed maturity securities due to rising interest rates. Separate account assets decreased $422 million primarily driven by net outflows on the runoff block and policy charges, partially offset by market appreciation and the impact of the asset transfer feature which moved customer account values from the general account to the separate account due to favorable markets in the first six months of 2013. Partially offsetting the above decreases was a $184 million increase in DAC and DSI primarily resulting from the impact of the mark-to-market of the reinsured liability for living benefit embedded derivatives and related hedge positions.</p>

Total liabilities decreased by $1.8 billion, from $51.6 billion at December 31, 2012 to $49.8 billion at June 30, 2013. Future policy benefits and other policyholder liabilities decreased $1.1 billion primarily driven by a decrease in the liability for living benefit embedded derivatives, as discussed above. Separate account liabilities decreased by $422 million offsetting the decrease in separate accounts assets above. Policyholder's account balance decreased by $340 million driven by account value runoff due to contractholder surrenders and the impact of the asset transfer feature which moved customer account values from the general account to the separate account, as discussed above.

Total equity increased by $0.1 billion from $1.2 billion at December 31, 2012 to $1.3 billion at June 30, 2013, primarily driven by net income partially offset by a dividend paid to our ultimate parent, Prudential Financial of $184 million and a decrease driven by unrealized gains on fixed maturity securities due to rising interest rates.

Results of Operations

2013 versus 2012 Three Month Comparison

Income (Loss) from Operations before Income Taxes

Income from operations before income taxes increased $528 million from a loss of $341 million for the second quarter of 2012 to income of $187 million for the second quarter of 2013. The increase was primarily driven by the impact on the amortization of DAC and other costs, and on the reserves for the guaranteed minimum death benefit ("GMDB") and guaranteed minimum income benefit ("GMIB") features, of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions and of changes in the estimated profitability of the business, as discussed in more detail below. Partially offsetting the benefit from these items was an unfavorable variance related to the mark-to-market of our non-reinsured living benefit features and related hedge positions, primarily due to larger non-performance risk ("NPR") losses in 2013 primarily driven by a decline in the base embedded liability due to rising interest rates, as well as larger net hedging losses mainly driven by fund performance.

The following table reflects the impact on the amortization of DAC and other costs and on the GMDB/GMIB reserves of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions, and of changes in the estimated profitability of the business.

                                                              Three Months Ended June 30,                                                              2013                 2012                                                                   ($ in millions)                                                                        (1) Impact of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions                                       $           141      $           (414) Impacts of changes in the estimated profitability of the business                                                    (3)                  (58)  Total                                                 $           138                  (472)     

(1) Amounts reflect (charges) or benefits for (increases) or decreases,

respectively, in the amortization of DAC and other costs and for GMDB/GMIB

reserve (increases) or decreases, respectively.

We amortize DAC and other costs over the expected lives of the contracts based on the level and timing of gross profits on the underlying product. In calculating gross profits, we consider mortality, persistency, and other elements as well as rates of return on investments associated with these contracts and include profits and losses related to these contracts that are reported in affiliated legal entities other than the Company as a result of, for example, reinsurance agreements with those affiliated entities. The Company is an indirect subsidiary of Prudential Financial (an SEC registrant) and has extensive transactions and relationships with other subsidiaries of Prudential Financial, including reinsurance agreements, as discussed in Note 7

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to the Unaudited Interim Financial Statements. Incorporating all product-related profits and losses in gross profits, including those that are reported in affiliated legal entities, produces an amortization pattern representative of the economics of the products.

The impact of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions, primarily relates to changes in the valuation of the reinsured living benefit liabilities related to NPR which we and the reinsurance affiliate believe to be noneconomic, and choose not to hedge. The favorable variance was driven by NPR losses in the reinsurance affiliate in 2013 compared to NPR gains in 2012, which resulted in an amortization benefit in 2013 compared to an amortization expense in 2012. NPR losses in the reinsurance affiliate in 2013 were primarily driven by a decline in the base embedded liability due to higher interest rates, while NPR gains in the reinsurance affiliate in 2012 were primarily driven by an increase in the base embedded liability due to lower interest rates and unfavorable equity market conditions.

The impacts of changes in the estimated profitability of the business include adjustments to the amortization of DAC and other costs and to GMDB and GMIB reserves for the impacts of market performance and current period experience. The $3 million net charge in the second quarter of 2013 was primarily driven by the negative experience related to the change of the fair value of the hedge target liability and the change in the fair value of the hedge assets primarily in the reinsurance affiliate due to differences in market conditions relative to our assumptions, partially offset by the impact of higher interest rates, which increased future expected fixed income returns on contractholder accounts and lowered future expected claims relative to our assumptions. For weighted average rate of return assumptions as of June 30, 2013 see "Application of Critical Accounting Estimates" above. The $58 million net charge in the second quarter of 2012 primarily reflects negative equity market performance on contractholder accounts relative to assumptions and negative experience related to the change of the fair value of the hedge target liability and the change in the fair value of the hedge assets primarily in the reinsurance affiliate due to differences in market conditions relative to our assumptions.

Revenues, Benefits and Expenses

Revenues decreased $92 million, primarily driven by a $79 million decrease in realized investment gains/losses, net, primarily due to an unfavorable variance related to our non-reinsured living benefit features, as discussed above. Net investment income decreased $10 million as a result of lower average annuity account values in the general account, primarily resulting from contractholder surrenders and net transfers from the fixed-rate option in the general account to the separate accounts relating to favorable markets and the asset transfer feature.

Benefits and expenses decreased $620 million, primarily driven by a benefit in DAC amortization of $37 million in the second quarter of 2013 compared to a charge in DAC amortization of $341 million in the second quarter of 2012. In addition, interest credited to policyholders' account balances, which includes DSI amortization decreased $222 million. Changes in DAC and DSI amortization were related to the impact of the mark-to-market of the reinsured liability for living benefit embedded derivatives and related hedge positions and the impact of changes in the estimated profitability of the business, as discussed above.

2013 versus 2012 Six Month Comparison

Income (Loss) from Operations before Income Taxes

Income from operations before income taxes increased $194 million from $190 million for 2012 to $384 million for 2013. The increase was primarily driven by the impact on the amortization of DAC and other costs, and on the reserves for the GMDB and GMIB features, of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions and of changes in the estimated profitability of the business, as discussed in more detail below. Partially offsetting the benefit from these items was an unfavorable variance related to the mark-to-market of our non-reinsured living benefit features and related hedge positions, primarily due to larger NPR losses in 2013 primarily driven by a decline in the base embedded liability due to rising interest rates, as well as larger net hedging losses mainly driven by fund performance.

The following table reflects the impact on the amortization of DAC and other costs and on the GMDB/GMIB reserves of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions, and of changes in the estimated profitability of the business.

                                                               Six Months Ended June 30,                                                              2013                 2012                                                                   ($ in millions)                                                                        (1) Impact of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions                                       $           284      $           (32) Impacts of changes in the estimated profitability of the business                                                   (15)                  34  Total                                                 $           269      $             2     

(1) Amounts reflect (charges) or benefits for (increases) or decreases,

respectively, in the amortization of DAC and other costs and for GMDB/GMIB

reserve (increases) or decreases, respectively.

The impact of the mark-to-market of the liability for living benefit embedded derivatives and related hedge positions, primarily relates to changes in the valuation of the reinsured living benefit liabilities related to NPR which we and the reinsurance affiliate believe to be noneconomic, and choose not to hedge. The favorable variance was driven by larger NPR losses in the reinsurance affiliate in 2013, which resulted in a larger amortization benefit in 2013. Larger NPR losses in the reinsurance affiliate in 2013 were primarily driven by lower base embedded derivative liability due to higher interest rates during the second quarter of 2013.

The impacts of changes in the estimated profitability of the business include adjustments to the amortization of DAC and other costs and to GMDB and GMIB reserves for the impacts of market performance and current period experience. The $15 million net charge in the first six months of 2013

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was primarily driven by the negative experience related to the change of the fair value of the hedge target liability and the change in the fair value of the hedge assets primarily in the reinsurance affiliate due to differences in market conditions relative to our assumptions, partially offset by the impact of higher interest rates, which increased future expected fixed income returns on contractholder accounts and lowered future expected claims relative to our assumptions as well as the impact of positive market performance on contractholder accounts relative to our assumptions. For weighted average rate of return assumptions as of June 30, 2013 see "Application of Critical Accounting Estimates" above. The $34 million net benefit in the second quarter of 2012 was primarily driven by the impact of positive market performance on contractholder accounts relative to our assumptions and positive experience related to the change of the fair value of the hedge target liability and the change in the fair value of the hedge assets primarily in the reinsurance affiliate due to differences in market conditions relative to our assumptions

Revenues, Benefits and Expenses

Revenues decreased $115 million, primarily driven by a $81 million decrease in realized investment gains/losses, net, primarily due to an unfavorable variance related to our non-reinsured living benefit features, as discussed above. Net investment income decreased $25 million as a result of lower average annuity account values in the general account, primarily resulting from contractholder surrenders and net transfers from the fixed-rate option in the general account to the separate accounts relating to favorable markets and the asset transfer feature.

Benefits and expenses decreased $309 million, primarily driven by a benefit in DAC amortization of $72 million in 2013 compared to a charge in DAC amortization of $109 million in 2012. In addition, interest credited to policyholders' account balances, which includes DSI amortization decreased $125 million. Changes in DAC and DSI amortization were related to the impact of the mark-to-market of the reinsured liability for living benefit embedded derivatives and related hedge positions and the impact of changes in the estimated profitability of the business, as discussed above.

Income Taxes

The income tax provision amounted to an expense of $43 million and a benefit of $104 million for the three months ended June 30, 2013 and 2012, respectively. The income tax provision amounted to an expense of $93 million and $55 million for the six months ended June 30, 2013 and 2012, respectively. The increases in income tax expense were primarily driven by the increases in pre-tax income.

The Company's liability for income taxes includes the liability for unrecognized tax benefits and interest that relate to tax years still subject to review by the Internal Revenue Service ("IRS") or other taxing authorities. The completion of review or the expiration of the Federal statute of limitations for a given audit period could result in an adjustment to the liability for income taxes. The statute of limitations for the 2009 tax year will expire in December 2014, unless extended. Tax years 2010 through 2012 are still open for IRS examination.

The Company does not anticipate any significant changes within the next 12 months to its total unrecognized tax benefits related to tax years for which the statute of limitations has not expired.

The dividends received deduction ("DRD") reduces the amount of dividend income subject to U.S. tax and is a significant component of the difference between the Company's effective tax rate and the federal statutory tax rate of 35%. The DRD for the current period was estimated using information from 2012, current year results, and was adjusted to take into account the current year's equity market performance. The actual current year DRD can vary from the estimate based on factors such as, but not limited to, changes in the amount of dividends received that are eligible for the DRD, changes in the amount of distributions received from mutual fund investments, changes in the account balances of variable life and annuity contracts, and the Company's taxable income before the DRD.

In August 2007, the IRS released Revenue Ruling 2007-54, which included, among other items, guidance on the methodology to be followed in calculating the DRD related to variable life insurance and annuity contracts. In September 2007, the IRS released Revenue Ruling 2007-61. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54 and informed taxpayers that the U.S. Treasury Department and the IRS intend to address through new guidance the issues considered in Revenue Ruling 2007-54, including the methodology to be followed in determining the DRD related to variable life insurance and annuity contracts. In May 2010, the IRS issued an Industry Director Directive ("IDD") confirming that the methodology for calculating the DRD set forth in Revenue Ruling 2007-54 should not be followed. The IDD also confirmed that the IRS guidance issued before Revenue Ruling 2007-54, which guidance the Company relied upon in calculating its DRD, should be used to determine the DRD. For the last several years, the revenue proposals included in the Obama Administration's budgets included a proposal that would change the method used to determine the amount of the DRD. A change in the DRD, including the possible retroactive or prospective elimination of this deduction through guidance or legislation, could increase actual tax expense and reduce the Company's consolidated net income. These activities had no impact on the Company's results for 2012 or for the six months ended June 30, 2013.

In 2009, the Company joined in filing the consolidated federal tax return with its parent, Prudential Financial. For tax years 2009 through 2012, the Company is participating in the IRS's Compliance Assurance Program ("CAP"). Under CAP, the IRS assigns an examination team to review completed transactions contemporaneously during these tax years in order to reach agreement with the Company on how they should be reported in the tax returns. If disagreements arise, accelerated resolutions programs are available to resolve the disagreements in a timely manner before the tax returns are filed. It is management's expectation this program will shorten the time period between the filing of the Company's federal income tax returns and the IRS's completion of its examination of the returns.

                          Liquidity and Capital Resources  

This section supplements and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources" included in our Annual Report on Form 10-K for the year ended December 31, 2012.

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Overview

Liquidity refers to the ability to generate sufficient cash resources to meet the payment obligations of the Company. Capital refers to the long term financial resources available to support the operations of our business, fund business growth, and provide a cushion to withstand adverse circumstances. The ability to generate and maintain sufficient liquidity and capital depends on the profitability of our business, general economic conditions and our access to the capital markets through affiliates as described herein.

Management monitors the liquidity of Prudential Financial, Prudential Insurance and the Company on a daily basis and projects borrowing and capital needs over a multi-year time horizon through our quarterly planning process. We believe that cash flows from the sources of funds available to us are sufficient to satisfy the current liquidity requirements of Prudential Financial and the Company, including reasonably foreseeable stress scenarios. We have a capital management framework in place that facilitates the allocation of capital and approval of capital uses, and we forecast capital sources and uses on a quarterly basis. Furthermore, we employ a "Capital Protection Framework" to ensure the availability of sufficient capital resources to maintain adequate capitalization and competitive risk-based capital ratios under reasonably foreseeable stress scenarios.

The Financial Stability Oversight Council has made a proposed determination that Prudential Financial should be subject to stricter prudential regulatory standards and supervision by the Board of Governors of the Federal Reserve System under the Dodd-Frank Act. This stricter prudential regulation may include new capital and liquidity standards, including requirements regarding risk-based capital, leverage, liquidity, stress-testing and other matters. For information on recent actions and the potential impact of the Dodd-Frank Act, see "Business-Regulation" and "Risk Factors" included in our 2012 Annual Report on Form 10-K for the year ended December 31, 2012 and updated "Risk Factors" included in this Quarterly Report on Form 10-Q.

The Financial Stability Oversight Council has made a proposed determination that Prudential Financial should be subject to stricter prudential regulatory standards and supervision by the Board of Governors of the Federal Reserve System under the Dodd-Frank Act. This stricter prudential regulation may include new capital and liquidity standards, including requirements regarding risk-based capital, leverage, liquidity, stress-testing and other matters. In addition, the Financial Stability Board, consisting of representatives of national financial authorities of the G20 nations, identified Prudential Financial as a global systemically important insurer. For information on these recent actions and their potential impact on us, see "Business-Regulation" and "Risk Factors" included in our 2012 Annual Report on Form 10-K.

On June 26, 2013, December 11, 2012 and June 29, 2012 the Company paid extraordinary dividends of $184 million, $160 million and $248 million, respectively, to its ultimate parent, Prudential Financial.

Capital

The Risk Based Capital, or RBC, ratio is a primary measure of the capital adequacy of the Company. RBC is determined by statutory guidelines and formulas that consider among other things, risks related to the type and quality of the invested assets, insurance-related risks associated with an insurer's products and liabilities, interest rate risks and general business risks. RBC is calculated based on statutory financial statements and risk formulas consistent with NAIC practices. The RBC ratio calculations are intended to assist insurance regulators in measuring the insurer's solvency and ability to pay future claims. The reporting of RBC measures is not intended for the purpose of ranking any insurance company or for use in connection with any marketing, advertising or promotional activities, but is available to the public. The RBC ratio is an annual calculation, however, as of June 30, 2013 we estimate that the Company's RBC ratio exceeds the minimum level required by applicable insurance regulations.

The regulatory capital level of the Company can be materially impacted by interest rate and equity market fluctuations, changes in the values of derivatives, the level of impairments recorded, and credit quality migration of the investment portfolio, among other items. Further, the recapture of business subject to reinsurance arrangements due to defaults by, or credit quality migration affecting, the reinsurers could result in higher required statutory capital levels. The regulatory capital level of the Company is also affected by statutory accounting rules which are subject to change by insurance regulators.

We employ a "Capital Protection Framework" to ensure sufficient capital resources are available to maintain adequate capitalization and a competitive risk based capital ratio, under reasonably foreseeable stress scenarios. The Capital Protection Framework incorporates the potential impacts from market related stresses, including equity markets, interest rates, and credit losses. Potential sources of capital include on-balance sheet capital, derivatives, reinsurance and contingent sources of capital. Although we continue to enhance our approach, we believe we currently have sufficient resources to maintain adequate capitalization and a competitive RBC ratio under reasonably foreseeable stress scenarios.

Prudential Financial and the Company use captive reinsurance companies to more effectively manage its capital on an economic basis and to enable the aggregation and transfer of risks. To support the risks they assume, the captives are capitalized to a level consistent with our "AA" financial strength ratings. In the normal course of business, Prudential Financial provides support to these captives through net worth maintenance agreements and/or guarantees of certain of the captives' obligations. Recently, the NAIC and the New York State Department of Financial Services have examined life insurers' use of captive reinsurance companies. We cannot predict what, if any, changes may result from these reviews. If applicable insurance laws are changed in a way that impairs the use of captive reinsurance companies, our ability to manage certain products risks could be adversely affected, which could adversely affect our capital and financial position and results of operations.

We manage certain risks associated with our variable annuity products through arrangements with an affiliated captive reinsurance company. We reinsure variable annuity living benefit guarantees to an affiliated captive reinsurance company, Pruco Re. This enables Prudential Financial to execute its living benefit hedging program within one legal entity, Pruco Re. In order for the Company to claim statutory reserve credit for business ceded to Pruco Re, Pruco Re must collateralize its obligation under the reinsurance agreement. This requirement is satisfied by Pruco Re depositing assets into statutory reserve credit trusts. Reinsurance reserve credit requirements can move materially in either direction due to changes in equity markets and interest rates, actuarial assumptions and other factors. Higher statutory reinsurance credit reserve requirements would require Pruco Re

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to deposit additional assets in the statutory reserve credit trusts, while lower statutory reinsurance credit reserve requirements would allow assets to be removed from the statutory reserve credit trusts. As of June 30, 2013, the statutory reserve credit trusts required collateral of $1.4 billion, a decrease of $0.7 billion from December 31, 2012. Pruco Re has deposited assets into statutory reserve credit trusts to satisfy this requirement. The decrease was primarily driven by favorable equity markets, partially offset by a decline in the long term interest rate assumptions we are required to use to calculate the associated reserve requirements.

Liquidity

There have been no material changes to the liquidity position of the Company since December 31, 2012. We continue to believe that cash generated by ongoing operations and the liquidity profile of our assets provide sufficient liquidity under reasonably foreseeable stress scenarios for the Company.

The principal sources of the Company's cash are certain annuity considerations, investment and fee income, investment maturities as well as internal borrowings. The principal uses of that liquidity include benefits, claims, and payments to policyholders and contractholders in connection with surrenders, withdrawals and net policy loan activity. Other uses of liquidity include commissions, general and administrative expenses, purchases of investments, and payments in connection with financing activities. As discussed above, in March 2010, the Company ceased offering its existing variable annuity products to new investors upon the launch of a new product line by certain affiliates. Therefore, the Company expects to continue to see the overall level of cash flows decrease going forward as the book of business runs off. We use a projection process for cash flows from operations to ensure sufficient liquidity is available to meet projected cash outflows, including claims.

Our liquidity is managed to ensure stable, reliable and cost-effective sources of cash flows to meet all of our obligations. Liquidity is provided by a variety of sources, as described more fully below, including portfolios of liquid assets. Our investment portfolios are integral to the overall liquidity of the Company. We segment our investment portfolios and employ an asset/liability management approach specific to the requirements of each of our product lines. This enhances the discipline applied in managing the liquidity, as well as the interest rate and credit risk profiles, of each portfolio in a manner consistent with the unique characteristics of the product liabilities.

Liquid assets include cash and cash equivalents, short-term investments and fixed maturities that are not designated as held-to-maturity and public equity securities. As of June 30, 2013 and December 31, 2012, the Company had liquid assets of $4.0 billion and $4.3 billion, respectively. The portion of liquid assets comprised of cash and cash equivalents and short-term investments was $0.2 billion and $0.1 billion as of June 30, 2013 and December 31, 2012, respectively. As of June 30, 2013, $3.5 billion, or 94%, of the fixed maturity investments in company general account portfolios were rated high or highest quality based on NAIC or equivalent rating. The remaining $0.2 billion, or 6%, of these fixed maturity investments were rated other than high or highest quality.

Prudential Financial and Prudential Funding, LLC, or Prudential Funding, a wholly-owned subsidiary of Prudential Insurance, borrow funds in the capital markets primarily through the direct issuance of commercial paper. The borrowings serve as an additional source of financing to meet our working capital needs. Prudential Funding operates under a support agreement with Prudential Insurance whereby Prudential Insurance has agreed to maintain Prudential Funding positive tangible net worth at all times.