PRUDENTIAL ANNUITIES LIFE ASSURANCE CORP/CT – 10-Q – 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 financial condition of Prudential Annuities
Life Assurance Corporation ("PALAC" or the "Company") as of September 30, 2021,
compared with December 31, 2020, and its results of operations for the three and
nine months ended September 30, 2021 and 2020. You should read the following
analysis of our financial condition and results of operations in conjunction
with the MD&A, the "Risk Factors" section, and the audited Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2020, as well as the statements under "Forward-Looking Statements",
and the Unaudited Interim Financial Statements included elsewhere in this
Quarterly Report on Form 10-Q.

                                    Overview

The Company was established in 1969 and has been a provider of 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 deferred and immediate
variable annuities with (1) fixed interest rate allocation options, subject to a
market value adjustment, that are registered with the United States Securities
and Exchange Commission (the "SEC"), and (2) fixed-rate allocation options
subject to a limited market value adjustment or no market value adjustment and
not registered with the SEC. The Company ceased offering these products in March
2010. In 2018, the Company resumed offering annuity products to new investors
(except in New York).

Effective April 1, 2016, the Company recaptured the risks related to its
variable annuity living benefit guarantees that were previously reinsured to
affiliates and reinsured the variable annuity base contracts, along with the
living benefit guarantees, from Pruco Life Insurance Company ("Pruco Life"),
excluding the Pruco Life Insurance Company of New Jersey ("PLNJ") business which
was reinsured to The Prudential Insurance Company of America ("Prudential
Insurance"), in each case under a coinsurance and modified coinsurance
agreement. This reinsurance agreement covers new and in force business and
excludes business reinsured externally. As of December 31, 2020, Pruco Life
discontinued the sales of traditional variable annuities with guaranteed living
benefit riders. The discontinuation has no impact on the reinsurance agreement
between Pruco Life and the Company. Additionally, the living benefit hedging
program related to the living benefit guarantees as well as the product risks
for retained and reinsured businesses are being managed within the Company and
Prudential Insurance, as applicable.

Effective July 1, 2021, Pruco Life recaptured the risks related to its business,
as discussed above, that had previously been reinsured to the Company from April
1, 2016 through June 30, 2021. The recapture does not impact PLNJ, which will
continue to reinsure its new and in force business to Prudential Insurance. The
product risks related to the previously reinsured business that were being
managed in the Company, were transferred to Pruco Life. In addition, the living
benefit hedging program related to the previously reinsured living benefit
riders will be managed within Pruco Life. This transaction is referred to as the
"2021 Variable Annuities Recapture".

Sale of PALAC

In September 2021, Prudential Annuities, Inc. ("PAI") entered into a definitive
agreement to sell its equity interest in PALAC to Fortitude Group Holdings, LLC.
The transaction will result in a benefit to Prudential Financial comprised of
the purchase price for PALAC, a pre-closing net capital distribution by PALAC
and an expected tax impact. The transaction is expected to close in the first
half of 2022, subject to the receipt of regulatory approvals and the
satisfaction of customary closing conditions.

COVID-19

Since the first quarter of 2020, the novel coronavirus ("COVID-19") has created
extreme stress and disruption in the global economy and financial markets and
has elevated mortality and morbidity experience for the global population. The
COVID-19 pandemic continues to impact our results of operations in the current
period and is expected to continue to impact our results of operations in future
periods. The COVID-19 pandemic has moved in localized waves, with its impact
worsening and then improving in different locations at different times in a
repetitive but unpredictable pattern. During the third quarter of 2021, the
mortality impacts to our businesses from COVID-19 increased compared to the
second quarter. The Company has taken several measures to manage the impacts of
this crisis. The actual and expected impacts of these events and other items are
included in the following update:

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•Risk Factors. The COVID-19 pandemic has adversely impacted our results of
operations, financial position, investment portfolio, new business opportunities
and operations, and these impacts are expected to continue. For additional
information on the risks to our business posed by the COVID-19 pandemic, see
"Risk Factors" included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2020.

•Business Continuity. Throughout the COVID-19 pandemic, we have been executing
Prudential Financial Inc.'s ("Prudential Financial") and our business continuity
protocols to ensure our employees are safe and able to serve our customers. This
included effectively transitioning the vast majority of our employees to remote
work arrangements.

We believe we can sustain remote work and social distancing for an indefinite
period while ensuring that critical business operations are sustained. In
addition, we are managing COVID-19-related impacts on third-party provided
services, and do not anticipate significant interruption in critical operations.

Impact of a Low Interest Rate Environment

As a financial services company, market interest rates are a key driver of our
results of operations and financial condition. Changes in interest rates can
affect our results of operations and/or our financial condition in several ways,
including favorable or adverse impacts to:

•investment-related activity, including: investment income returns, net interest
margins, net investment spread results, new money rates, mortgage loan
prepayments and bond redemptions;
•hedging costs and other risk mitigation activities;
•insurance reserve levels, amortization of deferred policy acquisition costs
("DAC")/value of business acquired ("VOBA")/deferred sales inducements ("DSI")
and market experience true-ups;
•customer account values, including their impact on fee income;
•fair value of, and possible impairments, on intangible assets;
•product offerings, design features, crediting rates and sales mix; and
•policyholder behavior, including surrender or withdrawal activity.

For more information on interest rate risks, see "Risk Factors-Market Risk"
included in our Annual Report on Form 10-K for the year ended December 31, 2020.

Revenues and Expenses

The Company earns revenues principally from contract charges, mortality and
expense fees, asset administration fees from annuity and investment products and
from net investment income on the investment of general account and other funds.
The Company earns contract fees, mortality and expense fees and asset
administration fees primarily from the sale and servicing of annuity products.
The Company's operating expenses principally consist of annuity benefit
guarantees provided and reserves established for anticipated future annuity
benefit guarantees and costs of managing risk related to these products,
interest credited to contractholders' account balances, general business
expenses, reinsurance premiums, commissions and other costs of selling and
servicing the various products it sold.

                      Accounting Policies & Pronouncements

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, the Company's results of operations and financial position as
reported in the Unaudited Interim Financial Statements could change
significantly.

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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:

•DAC, DSI and VOBA;
•Policyholder liabilities;
•Valuation of investments, including derivatives, measurement of allowance for
credit losses, and recognition of other-than temporary impairments;
•Reinsurance recoverables;
•Taxes on income; and
•Reserves for contingencies, including reserves for losses in connection with
unresolved legal matters.

Market Performance - Equity and Interest Rate Assumptions

DAC, DSI and VOBA associated with the variable and fixed annuity contracts are
generally amortized over the expected lives of these policies in proportion to
total gross profits. Total gross profits include both actual gross profits and
estimates of gross profits for future periods. The quarterly adjustments for
market performance reflect the impact of changes to our estimate of total gross
profits to reflect actual fund performance and market conditions. A significant
portion of gross profits for our variable annuity contracts are dependent upon
the total rate of return on assets held in separate account investment options.
This rate of return influences the fees we earn on variable annuity contracts,
costs we incur associated with the guaranteed minimum death and guaranteed
minimum income benefit features related to our variable annuity contracts, as
well as other sources of profit. Returns that are higher than our expectations
for a given period produce higher than expected account balances, which increase
the future fees we expect to earn on variable annuity contracts and decrease the
future costs we expect to incur associated with the guaranteed minimum death and
guaranteed minimum income benefit features related to our variable annuity
contracts. The opposite occurs when returns are lower than our expectations. The
changes in future expected gross profits are used to recognize a cumulative
adjustment to all prior periods' amortization.

Furthermore, the calculation of the estimated liability for future policy
benefits related to certain insurance products includes an estimate of
associated revenues and expenses that are dependent on both historical market
performance as well as estimates of market performance in the future. Similar to
DAC, DSI and VOBA described above, these liabilities are subject to quarterly
adjustments for experience including market performance, in addition to annual
adjustments resulting from our annual reviews of assumptions.

The weighted average rate of return assumptions used in developing estimated
market returns consider many factors specific to each product type, including
asset durations, asset allocations and other factors. With regard to equity
market assumptions, the near-term future rate of return assumption used in
evaluating DAC, DSI, and VOBA and liabilities for future policy benefits for
certain of our products, primarily our domestic variable annuity products, is
generally updated each quarter and is derived using a reversion to the mean
approach, a common industry practice. Under this approach, we consider
historical equity returns and adjust projected equity returns over an initial
future period of five years (the "near-term") so that equity returns converge to
the long-term expected rate of return. If the near-term projected future rate of
return is greater than our near-term maximum future rate of return of 15.0%, we
use our maximum future rate of return. If the near-term projected future rate of
return is lower than our near-term minimum future rate of return of 0%, we use
our minimum future rate of return. As of September 30, 2021, we assume an 8.0%
long-term equity expected rate of return and a 0.4% near-term mean reversion
equity expected rate of return.

With regard to interest rate assumptions used in evaluating DAC, DSI and VOBA
and liabilities for future policy benefits for certain of our products, we
generally update the long-term and near-term future rates used to project fixed
income returns annually and quarterly, respectively. As a result of our 2021
annual reviews and update of assumptions and other refinements, we kept our
long-term expectation of the 10-year U.S. Treasury rate unchanged and continue
to grade to a rate of 3.25% over ten years. As part of our quarterly market
experience updates, we update our near-term projections of interest rates to
reflect changes in current rates.

For a discussion of the impact that could result from changes in certain key
assumptions, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Accounting Policies and Pronouncements-Sensitivities
for Insurance Assets and Liabilities" in our Annual Report on Form 10-K for the
year ended December 31, 2020.
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Future Adoption of New Accounting Pronouncements
ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements
to the Accounting for Long-Duration Contracts, was issued by the Financial
Accounting Standards Board ("FASB") on August 15, 2018. In October 2019, the
FASB issued ASU 2019-09, Financial Services - Insurance (Topic 944): Effective
Date to affirm its decision to defer the effective date of ASU 2018-12 to
January 1, 2022 (with early adoption permitted), representing a one year
extension from the original effective date of January 1, 2021. As a result of
the COVID-19 pandemic, in November 2020 the FASB issued ASU 2020-11, Financial
Services-Insurance (Topic 944): Effective Date and Early Application to defer
for an additional one year the effective date of ASU 2018-12 from January 1,
2022 to January 1, 2023, and to provide transition relief to facilitate the
early adoption of the ASU. The transition relief would allow large calendar-year
public companies that early adopt ASU 2018-12 to apply the guidance either as of
January 1, 2020 or January 1, 2021 (and record transition adjustments as of
January 1, 2020 or January 1, 2021, respectively) in the 2022 financial
statements. Companies that do not early adopt ASU 2018-12 would apply the
guidance as of January 1, 2021 (and record transition adjustments as of January
1, 2021) in the 2023 financial statements. The Company currently intends to
adopt ASU 2018-12 effective January 1, 2023 using the modified retrospective
transition method where permitted.

ASU 2018-12 will impact, at least to some extent, the accounting and disclosure
requirements for all long-duration insurance and investment contracts issued by
the Company. The Company expects the standard to have a significant financial
impact on the Financial Statements and will significantly enhance disclosures.
In addition to significant impacts to the balance sheet upon adoption, the
Company also expects an impact to the pattern of earnings emergence following
the transition date. See Note 2 to the Unaudited Interim Financial Statements
for a more detailed discussion of ASU 2018-12, as well as other accounting
pronouncements issued but not yet adopted and newly adopted accounting
pronouncements.
                         Changes in Financial Position
Total assets decreased $14.1 billion from $64.3 billion at December 31, 2020 to
$50.2 billion at September 30, 2021. Significant components were:
•$9.2 billion decrease in Total investments and Cash and Cash equivalents
primarily driven by consideration paid related to the 2021 Variable Annuities
Recapture and dividend distributions; and
• $3.2 billion decrease in Deferred policy acquisition costs, primarily due to
the unwinding of assumed costs as part of the 2021 Variable Annuities Recapture.
Total liabilities decreased $13.4 billion from $61.6 billion at December 31,
2020 to $48.2 billion at September 30, 2021. Significant components were:
• $13.9 billion decrease in Future policy benefits primarily driven by the 2021
Variable Annuities Recapture and a decrease in reserves related to our variable
annuity living benefit guarantees due to rising interest rates and favorable
equity market performance;
Partially offset by:
•$1.5 billion increase in Policyholders' account balances primarily driven by
incremental general account product sales.
Total equity decreased $0.6 billion from $2.7 billion at December 31, 2020 to
$2.1 billion at September 30, 2021, primarily driven by a return of capital of
$3.8 billion related to the 2021 Variable Annuities Recapture and unrealized
losses on investments driven by rising interest rates reflected in Accumulated
other comprehensive income (loss), partially offset by an after-tax net income
of $4.8 billion, partially offset by dividend distributions of $0.4 billion.
                             Results of Operations
Income (loss) from Operations before Income Taxes
Three Months Comparison
Income (loss) from operations before income taxes increased $3.8 billion from a
loss of $47.6 million for the three months ended September 30, 2020 to a gain of
$3.7 billion for the three months ended September 30, 2021, primarily driven by:
•Significant Realized investment gains (losses), net reflecting a favorable
impact related to the 2021 Variable Annuities Recapture and the portion of our
U.S. GAAP liability before NPR, that are excluded from our hedge targets driven
by rising interest rates. Also contributing is an unfavorable NPR adjustment.
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Nine Months Comparison
Income (loss) from operations before income taxes increased $9.7 billion from a
loss of $3.7 billion for the nine months ended September 30, 2020 to income of
$6.0 billion for the nine months ended September 30, 2021. Excluding the impact
of our annual reviews and update of assumptions and other refinements, income
(loss) from operations increased $9.7 billion primarily driven by:
•Significant Realized investment gains (losses), net reflecting a favorable
impact related to the 2021 Variable Annuities Recapture and the portions of our
U.S. GAAP liability before NPR, that are excluded from our hedge target driven
by rising interest rates and favorable equity market performance. Also
contributing is an unfavorable NPR adjustment.
The following table provides the net impact to the Unaudited Interim Statements
of Operations, which is primarily driven by the changes in the U.S. GAAP
embedded derivative liability and hedge positions under the Asset Liability
Management ("ALM") strategy, and the related amortization of DAC and other
costs.

                                                         Three Months Ended                            Nine Months Ended
                                                                         September 30,         September 30,         September 30,
                                               September 30, 2021             2020                  2021                 2020
                                                          (in millions)(1)                              (in millions)(1)
U.S. GAAP embedded derivative and hedging
positions
Change in value of U.S.GAAP liability,
pre-NPR(2)                                    $           47             $  

3,164 $ 5,628 $ (11,495)
Change in the NPR adjustment

                             (47)                   (541)                  (950)              2,179
Change in fair value of hedge assets,
excluding capital hedges(3)                               63                  (2,169)                (3,049)              5,633
Change in fair value of capital hedges(4)                 37                    (366)                  (766)               (129)
2021 Variable Annuities Recapture Impact               5,142                          0               5,142                      0
Other                                                   (203)                    237                    903                 880
Realized investment gains (losses), net, and
related adjustments                                    5,039                     325                  6,908              (2,932)
Market experience updates(5)                             (14)                      6                    147                (229)
Charges related to realized investments gains
(losses), net                                             14                    (127)                  (246)                 20
Net impact from changes in the U.S. GAAP
embedded derivative and hedge positions,
after the impact of NPR, DAC and other
costs(6)                                      $        5,039             $  

204 $ 6,809 $ (3,141)

(1)Positive amount represents income; negative amount represents a loss.
(2)Represents the change in the liability (excluding NPR) for our variable
annuities which is measured utilizing a valuation methodology that is required
under U.S. GAAP. This liability includes such items as risk margins which are
required by U.S. GAAP but not included in our best estimate of the liability.
(3)Represents the changes in fair value of the derivatives utilized to hedge
potential claims associated with our variable annuity living benefit guarantees.
(4)Represents the changes in fair value of equity derivatives of the capital
hedge program intended to protect a portion of the overall capital position of
our business against exposure to the equity markets.
(5)Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability.
(6)Excludes amounts from the changes in unrealized gains and losses from fixed
income instruments recorded in OCI (versus net income) of $(45) million and
$(30) million for the three months ended September 30, 2021 and 2020,
respectively, and $1,673 million and $1,563 million for the nine months ended
September 30, 2021 and 2020, respectively.

For the three months ended September 30, 2021, the gain of $5,039 million was
driven by favorable impact related to 2021 Variable Annuities Recapture. See
Note 1 to the Unaudited Interim Financial Statements for further
details.
For the three months ended September 30, 2020, the gain of $204 million was
driven by a favorable impact related to the U.S. GAAP liability before NPR, net
of the change in the fair value of hedge assets (excluding capital hedges)
largely due to rising interest rates and favorable equity market performance.
Also contributing are unfavorable NPR adjustment and losses on capital hedges
driven by favorable equity market performance.
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For the nine months ended September 30, 2021, the gain of $6,809 million was
driven by favorable impact related to 2021 Variable Annuities Recapture and the
portions of our U.S. GAAP liability before NPR, net of the change in fair value
of hedge assets (excluding capital hedges) primarily driven by rising interest
rates and favorable equity market performance. Also contributing is an
unfavorable NPR adjustment.
For the nine months ended September 30, 2020, the loss of $3,141 million was
primarly driven by unfavorable impact related to the U.S. GAAP liability before
NPR, net of the change in fair value of hedge assets (excluding capital hedges)
primarily driven by declining interest rates and widening of credit spreads.
Those losses were partially offset by a favorable NPR adjustment, reflecting the
impact of widening of credit spreads.

Revenues, Benefits and Expenses
Three Months Comparison
Revenues increased $4.8 billion from a gain of $0.5 billion for the three months
ended September 30, 2020 to a gain of $5.3 billion for the three months ended
September 30, 2021 primarily driven by:
•Significant Realized investment gains (losses), net reflecting a favorable
impact related to the 2021 Variable Annuities Recapture and the portion of our
U.S. GAAP liability before NPR, that are excluded from our hedge targets driven
by rising interest rates. Also contributing is an unfavorable NPR adjustment.
Benefits and expenses increased $0.9 billion from $0.6 billion for the three
months ended September 30, 2020 to $1.5 billion for the three months ended
September 30, 2021 primarily driven by:
•Higher Commission expense primarily driven by the unwinding of assumed deferred
acquisition costs, partially offset by ceding allowance received as part of the
2021 Variable Annuities Recapture.
Nine Months Comparison
Revenues increased $10.7 billion from a loss of $2.1 billion for the nine months
ended September 30, 2020 to a gain of $8.6 billion for the nine months ended
September 30, 2021. Excluding the impact of our annual reviews and update to our
assumptions and other refinements, revenues increased $10.8 billion primarily
driven by:
•Significant Realized investment gains (losses), net reflecting a favorable
impact related to the 2021 Variable Annuities Recapture and the portions of our
U.S. GAAP liability before NPR, that are excluded from our hedge target driven
by rising interest rates and favorable equity market performance. Also
contributing is an unfavorable NPR adjustment.
Benefits and expenses increased $1.0 billion from $1.6 billion for the nine
months ended September 30, 2020 to $2.6 billion for the nine months ended
September 30, 2021. Excluding the impact of our annual reviews and update to our
assumptions and other refinements, benefits and expenses increased $1.1 billion
primarily driven by:
•Higher Commission expense primarily driven by the unwinding of assumed deferred
acquisition costs, partially offset by ceding allowance received as part of the
2021 Variable Annuities Recapture.
Risks and Risk Mitigants
Fixed Annuity Risks and Risk Mitigants. The primary risk exposure of our fixed
annuity product relates to investment risks we bear for providing customers a
minimum guaranteed interest rate or an index-linked interest rate required to be
credited to the customer's account value, which include interest rate
fluctuations and/or sustained periods of low interest rates, and credit risk
related to the underlying investments. We manage these risk exposures primarily
through our investment strategies and product design features, which include
credit rate resetting subject to the minimum guaranteed interest rate, as well
as surrender charges applied during the early years of the contract that help to
provide protection from premature withdrawals. In addition, a portion of our
fixed annuity products has a market value adjustment provision that affords
protection of lapse in the case of rising interest rates. We also manage these
risk exposures through external reinsurance for certain of our fixed annuity
products.
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Indexed Variable Annuity Risks and Risk Mitigants. The primary risk exposure of
our indexed variable annuity products relates to the investment risks we bear in
order to credit to the customer's account balance the required crediting rate
based on the performance of the elected indices at the end of each term. We
manage this risk primarily through our investment strategies including
derivatives and product design features, which include credit rate resetting
subject to contractual minimums as well as surrender charges applied during the
early years of the contract that help to provide protection from premature
withdrawals. In addition, our indexed variable annuity strategies have an
interim value provision that provides protection from lapse in the case of
rising interest rates.
Variable Annuity Risks and Risk Mitigants. 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 capital
markets assumptions such as equity market returns, interest rates and market
volatility, along with actuarial assumptions such as contractholder mortality,
the timing and amount of annuitization and withdrawals, and contract lapses. For
these risk exposures, achievement of our expected returns is subject to the risk
that actual experience will differ from the assumptions used in the original
pricing of these products. We manage our exposure to certain risks driven by
fluctuations in capital markets primarily through a combination of i) Product
Design Features, ii) our Asset Liability Management Strategy, and iii) our
Capital Hedge Program as discussed below. We also manage these risk exposures
through external reinsurance for certain of our variable annuity products. Sales
of traditional variable annuities with guaranteed living benefit riders were
discontinued as of December 31, 2020, and, in the third quarter of 2021, we
announced that we had entered into an agreement to sell a portion of the
in-force traditional variable annuity block, as described above.

Effective July 1, 2021, Pruco Life recaptured the risks related to its business
that had previously been reinsured to the Company from April 1, 2016 through
June 30, 2021. The recapture does not impact PLNJ, which will continue to
reinsure its new and in force business to Prudential Insurance. The product
risks related to the previously reinsured business that were being managed in
the Company, were transferred to Pruco Life. In addition, the living benefit
hedging program related to the previously reinsured living benefit riders will
be managed within Pruco Life. For more information on this transaction, see Note
1 to the Unaudited Interim Financial Statements.
i. Product Design Features:
A portion of the variable annuity contracts that we offered include an asset
transfer feature. This feature is implemented at the contract level, and
transfers assets between certain variable investment sub-accounts selected by
the annuity contractholder and, depending on the benefit feature, a fixed-rate
account in the general account or a bond fund sub-account within the separate
account. The objective of the asset transfer feature is to reduce our exposure
to equity market risk and market volatility. The transfers are based on a static
mathematical formula used with the particular benefit which considers a number
of factors, including, but not limited to, the impact of investment performance
on the contractholder's total account value. Other product design features we
utilize include, among others, asset allocation restrictions, minimum issuance
age requirements and certain limitations on the amount of contractholder
purchase payments, as well as a required minimum allocation to our general
account for certain of our products. In addition, there is diversity in our fee
arrangements, as certain fees are primarily based on the benefit guarantee
amount, the contractholder account value and/or premiums, which helps preserve
certain revenue streams when market fluctuations cause account values to
decline.
ii. Asset Liability Management Strategy (including fixed income instruments and
derivatives):
We employ an ALM strategy that utilizes a combination of both traditional fixed
income instruments and derivatives to meet expected liabilities associated with
our variable annuity living benefit guarantees. The economic liability we manage
with this ALM strategy consists of expected living benefit claims under less
severe market conditions, which are managed using fixed income instruments,
derivatives, or a combination thereof, and potential living benefit claims
resulting from more severe market conditions, which are hedged using derivative
instruments. For the portion of our ALM strategy executed with derivatives, we
enter into a range of exchange-traded and over-the-counter ("OTC") equity,
interest rate and credit derivatives, including, but not limited to: equity and
treasury futures; total return, credit default and interest rate swaps; and
options, including equity options, swaptions, and floors and caps. The intent of
this strategy is to more efficiently manage the capital and liquidity associated
with these products while continuing to mitigate fluctuations in net income due
to movements in capital markets.
The valuation of the economic liability we seek to defray excludes certain items
that are included within the U.S. GAAP liability, such as NPR in order to
maximize protection irrespective of the possibility of our own default, as well
as risk margins (required by U.S. GAAP but different from our best estimate) and
valuation methodology differences. The following table provides a reconciliation
between the liability reported under U.S. GAAP and the economic liability we
manage through our ALM strategy as of the periods indicated:
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                                                        As of September 30,         As of December 31,
                                                                2021                     2020(1)
                                                                         (in millions)
U.S. GAAP Liability, including NPR                      $           3,898          $          16,905
NPR Adjustment                                                        517                      3,705
   Subtotal                                                         4,415                     20,610
Adjustments including risk margins and valuation
methodology differences                                            (1,353)                    (4,596)
   Economic liability managed by ALM strategy           $           3,062          $          16,014


(1)Prior period amounts have been updated to conform to current period
presentation. Amounts are presented net of reinsurance recoverables.
As of September 30, 2021, the fair value of our fixed income instruments and
derivative assets exceed our economic liability.
Under our ALM strategy, we expect differences in the U.S. GAAP net income impact
between the changes in value of the fixed income instruments (either designated
as available-for-sale or designated as trading) and derivatives as compared to
the changes in the embedded derivative liability these assets support. These
differences can be primarily attributed to three distinct areas:
•Different valuation methodologies in measuring the liability we intend to cover
with fixed income instruments and derivatives versus the liability reported
under U.S. GAAP. The valuation methodology utilized in estimating the economic
liability we intend to defray with fixed income instruments (either designated
as available-for-sale or designated as trading) and derivatives is different
from that required to be utilized to measure the liability under U.S. GAAP.
Additionally, the valuation of the economic liability excludes certain items
that are included within the U.S. GAAP liability, such as NPR in order to
maximize protection irrespective of the possibility of our own default and risk
margins (required by U.S. GAAP but different from our best estimate).
•Different accounting treatment between liabilities and assets supporting those
liabilities. Under U.S. GAAP, changes in value of the embedded derivative
liability, derivative instruments and fixed income instruments designated as
trading immediately reflected in net income, while changes in the fair value of
fixed income instruments that are designated as available-for-sale are recorded
as unrealized gains (losses) in other comprehensive income.
•General hedge results. For the derivative portion of the ALM strategy, the net
hedging impact (the extent to which the changes in value of the hedging
instruments offset the change in value of the portion of the economic liability
we are hedging) may be impacted by a number of factors, including: cash flow
timing differences between our hedging instruments and the corresponding portion
of the economic liability we are hedging, basis differences attributable to
actual underlying contractholder funds to be hedged versus hedgeable indices,
rebalancing costs related to dynamic rebalancing of hedging instruments as
markets move, certain elements of the economic liability that may not be hedged
(including certain actuarial assumptions), and implied and realized market
volatility on the hedge positions relative to the portion of the economic
liability we seek to hedge.
For information regarding the Risk Appetite Framework ("RAF") we use to evaluate
and support the risks of the ALM strategy, see "-Liquidity and Capital
Resources-Capital".
iii. Capital Hedge Program:
We employ a capital hedge program within the Company to protect a portion of the
overall capital position of the variable annuities business against its exposure
to the equity markets. The capital hedge program is conducted using equity
derivatives which include equity call and put options, total return swaps and
futures contracts.
                                  Income Taxes

For information regarding income taxes, see Note 7 to the Unaudited Interim
Financial Statements.

                        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, 2020.
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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. Our
ability to generate and maintain sufficient liquidity and capital depends on the
profitability of our business, general economic conditions, our ability to
borrow from affiliates and our access to the capital markets through affiliates
as described herein.
Effective and prudent liquidity and capital management is a priority across the
organization. Management monitors the liquidity of the Company on a daily basis
and projects borrowing and capital needs over a multi-year time horizon. We use
a RAF to ensure that all risks taken by the Company aligns with our capacity and
willingness to take those risks. The RAF provides a dynamic assessment of
capital and liquidity stress impacts, including scenarios similar to, and more
severe than, those occurring due to COVID-19, and is intended to ensure that
sufficient resources are available to absorb those impacts. We believe that our
capital and liquidity resources are sufficient to satisfy the capital and
liquidity requirements of the Company.
Our businesses are subject to comprehensive regulation and supervision by
domestic and international regulators. These regulations currently include
requirements (many of which are the subject of ongoing rule-making) relating to
capital, leverage, liquidity, stress-testing, overall risk management, credit
exposure reporting and credit concentration. For information on these regulatory
initiatives and their potential impact on us, see "Business-Regulation" and
"Risk Factors" included in our Annual Report on Form 10-K for the year ended
December 31, 2020.
In September 2021, PAI entered into a definitive agreement to sell its equity
interest in PALAC to Fortitude Group Holdings, LLC. The transaction will result
in a benefit to Prudential Financial comprised of the purchase price for PALAC,
a pre-closing net capital distribution by PALAC and an expected tax impact. The
transaction is expected to close in the first half of 2022, subject to the
receipt of regulatory approvals and the satisfaction of customary closing
conditions.
Capital
We manage PALAC to regulatory capital levels consistent with our "AA" ratings
targets. We utilize the risk-based capital ("RBC") ratio as a primary measure of
capital adequacy. RBC is calculated based on statutory financial statements and
risk formulas consistent with the practices of the National Association of
Insurance Commissioners ("NAIC"). RBC considers, 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 ratio calculations are intended to assist insurance
regulators in measuring an 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 Company's capital
levels substantially exceed the minimum level required by applicable insurance
regulations. Our regulatory capital levels may be affected in the future by
changes to the applicable regulations, proposals for which are currently under
consideration by both domestic and international insurance regulators.
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. In addition, the reinsurance of
business or the recapture of business subject to reinsurance arrangements due to
defaults by, or credit quality migration affecting, the reinsurers or for other
reasons could negatively impact regulatory capital levels. The Company's
regulatory capital level is also affected by statutory accounting rules, which
are subject to change by each applicable insurance regulator.
The Company made distributions to its parent, PAI, for the three month periods
indicated below.
                                       Return of Capital       Dividends
                                                 (in millions)
                 September 30, 2021   $            3,813      $        0
                 June 30, 2021        $                0      $      188
                 March 31, 2021       $                0      $      192
                 December 31, 2020    $              188      $        0
                 September 30, 2020   $              192      $        0


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Liquidity
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 use a projection process for cash flows from operations to ensure
sufficient liquidity to meet projected cash outflows, including claims. The
impact of Prudential Funding, LLC's ("Prudential Funding"), a wholly-owned
subsidiary of Prudential Insurance, financing capacity on liquidity (as
described below) is considered in the internal liquidity measures of the
Company.
Liquidity is measured against internally-developed benchmarks that take into
account the characteristics of both the asset portfolio and the liabilities that
they support. We consider attributes of the various categories of liquid assets
(for example, type of asset and credit quality) in calculating internal
liquidity measures to evaluate our liquidity under various stress scenarios,
including company-specific and market-wide events. 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.
The principal sources of the Company's liquidity are premiums and certain
annuity considerations, investment and fee income, investment maturities, sales
of investments and 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, the payment of dividends and returns of capital to the parent
company, hedging and reinsurance activity and payments in connection with
financing activities.
In managing liquidity, we consider the risk of policyholder and contractholder
withdrawals of funds earlier than our assumptions when selecting assets to
support these contractual obligations. We use surrender charges and other
contract provisions to mitigate the extent, timing and profitability impact of
withdrawals of funds by customers.
Liquid Assets
Liquid assets include cash and cash equivalents, short-term investments, U.S.
Treasury fixed maturities and fixed maturities that are not designated as
held-to-maturity, and public equity securities. As of September 30, 2021 and
December 31, 2020, the Company had liquid assets of $12.7 billion and $21.4
billion, respectively. The portion of liquid assets comprised cash and cash
equivalents and short-term investments was $1.5 billion and $1.4 billion as of
September 30, 2021 and December 31, 2020, respectively. As of September 30,
2021, $10 billion, or 91%, of the fixed maturity investments in the Company's
general account portfolios, were rated high or highest quality based on NAIC or
equivalent rating.
Financing activities
Prudential Funding, LLC
Prudential Financial and Prudential Funding 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's
positive tangible net worth at all times.
Hedging activities associated with living benefit guarantees
The hedging portion of our risk management strategy associated with our living
benefit guarantees, including those assumed from Pruco Life, is being managed
within the Company. For the portion of the risk management strategy executed
through hedging, we enter into a range of exchange-traded, cleared and other OTC
equity and interest rate derivatives in order to hedge certain living benefit
guarantees accounted for as embedded derivatives against changes in certain
capital market risks above a designated threshold. The portion of the risk
management strategy comprising the hedging portion requires access to liquidity
to meet the Company's payment obligations relating to these derivatives, such as
payments for periodic settlements, purchases, maturities and terminations. These
liquidity needs can vary materially due to, among other items, changes in
interest rates, equity markets, mortality and policyholder behavior.
The hedging portion of the risk management strategy may also result in
derivative-related collateral postings to (when we are in a net pay position) or
from (when we are in a net receive position) counterparties. The net collateral
position depends on changes in interest rates and equity markets related to the
amount of the exposures hedged. Depending on market conditions, the collateral
posting requirements can result in material liquidity needs when we are in a net
pay position.
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