In managing our business, we analyze our operating performance by separately considering our Financial Services Businesses and our Closed Block Business. In addition, within the Financial Services Businesses, we analyze our operating performance using a non-GAAP measure we call "adjusted operating income." Prior to the date of demutualization, we also analyzed results of our Traditional Participating Products segment based on this non-GAAP measure. We calculate adjusted operating income by adjusting our income from continuing operations before income taxes to exclude certain items. The items excluded are:

• realized investment gains, net of losses and related charges;
• sales practices remedies and costs;
• the gains, losses and contribution to income/loss of divested businesses that we have sold but that do not qualify for "discontinued operations" accounting treatment under GAAP; and
• demutualization costs and expenses.

Wind-down businesses that we have not divested remain in adjusted operating income. We exclude our discontinued healthcare operations from income from continuing operations before income taxes.

The excluded items are important to an understanding of our overall results of operations. You should not view adjusted operating income as a substitute for net income determined in accordance with GAAP, and you should note that our definition of adjusted operating income may differ from that used by other companies. However, we believe that the presentation of adjusted operating income as we measure it for management purposes enhances the understanding of our results of operations by highlighting the results from ongoing operations and the underlying profitability of our businesses. We exclude realized investment gains, net of losses and related charges, from adjusted operating income, because the timing of transactions resulting in recognition of gains or losses is largely at our discretion and the amount of these gains or losses is heavily influenced by and fluctuates in part according to the availability of market opportunities. Including the fluctuating effects of these transactions could distort trends in the underlying profitability of our businesses. We exclude sales practices remedies and costs because they relate to a substantial and identifiable non-recurring event. We exclude the gains and losses and contribution to income/loss of divested businesses because, as a result of our decision to dispose of these businesses, these results are not relevant to the profitability of our ongoing operations and could distort the trends associated with our ongoing operations. We also exclude demutualization costs and expenses because they are directly related to our demutualization and could distort the trends associated with our business operations.

In the discussion below of our consolidated results of operations, we separately discuss income from continuing operations before income taxes and adjusted operating income for the Financial Services Businesses, as well as the divisions thereof and Corporate and Other operations, and the Closed Block Business. We also discuss the items excluded from adjusted operating income, i.e., realized investment gains, sales practices remedies and costs, demutualization costs and expenses and divested businesses, as well as items not included in income from continuing operations before taxes, i.e., taxes and discontinued operations. Realized investment gains and losses are allocated between the Financial Services Businesses and the Closed Block Business. Sales practices remedies and costs and divested businesses are allocated entirely to the Financial Services Businesses. For purposes of analyzing our results, taxes and discontinued operations are not allocated to our segments or divisions. Following this consolidated discussion, you will find a detailed discussion of our results of operations by division and by the segments of each division, as well as the Closed Block Business.

Net Income
2001 to 2000 Annual Comparison. On a consolidated basis net income decreased $552 million from income of $398 million in 2000 to a loss of $154 million in 2001. The decrease reflects a $954 million decrease in income from continuing operations before income taxes, partially offset by a $463 million decrease in the related provision for income taxes as discussed below under "—Taxes". Our $154 million net loss in 2001 included a net loss of $506 million for the fourth quarter of 2001. The $506 million net loss reflects a loss from continuing operations before income taxes of $609 million, including net realized investment losses of $435 million, demutualization costs and expenses of $389 million, and adjusted operating income of $320 million.

The $954 million decrease in income from continuing operations before income taxes resulted from a $142 million decrease from the Financial Services Businesses and a $812 million decrease from the Closed Block Business. The $142 million decrease from the Financial Services Businesses came primarily from a $534 million decline from our U.S. Consumer division, a $244 million decline from our Employee Benefits division, and an $66 million decline from our Asset Management division, partially offset by an increase of $159 million from our International division and a $543 million reduction in losses from Corporate and Other operations.

The $534 million decline from our U.S. Consumer division, the $244 million decline from our Employee Benefits division and the $66 million decline from our Asset Management division came primarily from decreases in adjusted operating income. The $159 million increase from our International division came from an increase in adjusted operating income. Results for our International division include the results of Gibraltar Life, which we acquired in April 2001, from April 2, 2001 through November 30, 2001. The $543 million reduction in losses from Corporate and Other operations came primarily from a $467 million increase in realized investment gains, net of losses, and a $489 million decrease in losses from divested businesses which were partially offset by a $445 million increase in demutualization costs and expenses and a $32 million improvement in adjusted operating income.

Net income on an equivalent share basis assumes that shares issued in the demutualization and the initial public offering were outstanding for all periods and does not reflect adjustments to earnings for demutualization or related transactions. Net income per equivalent share of Common Stock, which reflects the performance of the Financial Services Businesses, decreased to 52 cents per equivalent Common Share for the year ended December 31, 2001, from 53 cents per equivalent Common Share for the year ended December 31, 2000. Also on an equivalent share basis, net income per equivalent share of the Class B Stock, which reflects the performance of the Closed Block Business, decreased to a loss of $228.00 per equivalent share of Class B Stock for the year ended December 31, 2001, from income of $43.50 per equivalent share of Class B Stock for the year ended December 31, 2000. The decrease in net income per equivalent share of the Common Stock and Class B Stock from 2000 to 2001 reflects the decline in net income of the Financial Services Businesses and Closed Block Business as discussed above.

See "—Adjusted Operating Income" below for a discussion of the adjusted operating income results of our divisions, Corporate and Other operations and our Closed  Block Business.

See "—Realized Investment Gains" below for a discussion of realized investment gains, net of losses, and charges related to net realized investment gains.

Terrorist Attacks on the United States
Our losses from insurance claims arising in connection with the September 11, 2001 terrorist attacks, after release of existing reserves and reinsurance recoveries, had a negative effect on adjusted operating income and income from continuing operations before income taxes of approximately $37 million, and on net income of approximately $23 million, for 2001. These insurance losses are based on gross losses of approximately $172 million from group life, individual life, and property and casualty insurance claims. Approximately $27 million of the negative impact on adjusted operating income and income from continuing operations before income taxes related to the Financial Services Businesses, primarily in the Individual Life Insurance segment. The remainder of the losses related to the Closed Block Business.

We suffered no material injury to our personnel or properties used in our business operations from the attacks.

2000 to 1999 Annual Comparison. Net income decreased $415 million, or 51%, from $813 million in 1999 to $398 million in 2000. This decrease reflects a $1.528 billion decrease in income from continuing operations before income taxes, partially offset by a $636 million decrease in the related provision for income taxes as discussed below under "—Taxes." Additionally, net income for 2000 included $77 million of income resulting from a reduction in our loss on disposal of our discontinued healthcare operations, while 1999 net income included a $400 million increase in our loss on disposal of these operations, as discussed below under "—Discontinued Operations."

The $1.528 billion decrease in income from continuing operations before income taxes resulted from a $1.377 billion decrease from the Financial Services Businesses and a $151 million decrease from the Closed Block Business. The $1.377 billion decrease from the Financial Services Businesses came primarily from a $1.335 billion decline from Corporate and Other operations and a $216 million decline from our Employee Benefits division, partially offset by an $85 million increase from our U.S. Consumer division and a $65 million increase from our International division. The $1.335 billion decline from Corporate and Other operations came primarily from a $637 million decline in realized investment gains, net of losses, and from a $643 million decline from the former lead-managed underwriting and institutional fixed income businesses of Prudential Securities, which we include in "divested businesses." The $216 million decline from our Employee Benefits division came primarily from a $203 million decline in realized investment gains, net of losses and related charges. The $85 million increase from our U.S. Consumer division came primarily from a $73 million increase in adjusted operating income. The $65 million increase from our International division reflected an $89 million increase in adjusted operating income.

Adjusted Operating Income
2001 to 2000 Annual Comparison. On a consolidated basis, adjusted operating income decreased $569 million, or 25%, from $2.268 billion for 2000 to $1.699 billion for 2001. Our adjusted operating income for the fourth quarter of 2001 was $320 million, reflecting adjusted operating income of $173 million for the Financial Services Businesses and $147 million for the Closed Block Business. Adjusted operating income in the Financial Services Businesses for the fourth quarter of 2001 reflected declines in results in the U.S. Consumer and Employee Benefits divisions compared to prior periods of 2001. The decrease for the year ended December 31, 2001 came from a $458 million decrease from the Financial Services Businesses, and a $111 million decrease from the Closed Block Business. Adjusted operating income of our Financial Services Businesses for 2001 includes $262 million, which represents Gibraltar Life's results from April 2, 2001 through November 30, 2001.

Adjusted operating income of our Financial Services Businesses decreased $458 million, or 27%, from 2000 to 2001. The decrease came primarily from decreases of $430 million from our U.S. Consumer division and $204 million from our Employee Benefits division, partially offset by a $201 million increase in adjusted operating income from our International division, including the $262 million contribution of Gibraltar Life in 2001.

The $430 million decrease in adjusted operating income from our U.S. Consumer division came primarily from a $476 million decrease from the Private Client Group segment. The $204 million decrease in adjusted operating income from our Employee Benefits division came from declines in both segments in the division.

Adjusted operating income of the Closed Block Business decreased $111 million, or 20%, from 2000 to 2001, primarily from a $144 million reserve for unreported death claims and related expenses and a decline in net investment income resulting from the transfer of assets previously associated with our Traditional Participating Products segment to the Financial Services Businesses in connection with the establishment of the Closed Block Business on the date of demutualization. These declines were partially offset by a reduction in the charge for policyholder dividends, which excludes the portion of the dividend related to net realized investment gains, a reduction in amortization of deferred policy acquisition costs and a decline in operating expenses.

2000 to 1999 Annual Comparison. On a consolidated basis, adjusted operating income increased $263 million, or 13%, from 1999 to 2000. The increase came from a $231 million increase from the Closed Block Business and a $32 million increase from the Financial Services Businesses.

Adjusted operating income of our Financial Services Businesses increased $32 million, or 2%, from 1999 to 2000. The increase came primarily from increases of $89 million from our International division and $73 million from our U.S. Consumer division, partially offset by a $141 million decrease from Corporate and Other operations.

The $89 million increase in adjusted operating income from our International division came primarily from a $78 million increase from the International Insurance segment. The $73 million increase in adjusted operating income from our U.S. Consumer division came primarily from an increase of $65 million from the Retail Investments segment. The $141 million decrease from Corporate and Other operations came primarily from corporate-level activities, which included a one-time benefit of $114 million recognized in 1999 as a result of a reduction of recorded liabilities for our own employee benefits.

Adjusted operating income of the Closed Block Business increased $231 million, or 73%, from 1999 to 2000, primarily as a result of an increase in investment income net of interest expense and a decline in operating expenses.

Realized Investment Gains
We have frequently used an active management strategy for a significant portion of our public fixed maturity investment portfolio to maximize the overall return on our investments, subject to our adjusted operating income objectives. The implementation of this strategy resulted in significant realized investment losses in 2000 and 1999. When applied during a period of generally declining interest rates, we expect that using this strategy will result in lower investment income partially offset by realized investment gains. Conversely, when applied during a period of generally rising interest rates, we expect that using this strategy will result in increased investment income offset by realized investment losses. The amount of our gains or losses also depends on relative value opportunities and other variables. In consideration of our adjusted operating income objectives, and other factors, we may choose, at times, to constrain our active management and, therefore, the magnitude of realized investment gains or losses.

In addition, we require most issuers of private fixed maturity securities to pay us make-whole yield maintenance payments when they prepay the securities. Prepayment levels are also driven by the interest rate environment and other factors not within our control. The prepayment of private fixed maturities we held contributed realized investment gains of $155 million in the year ended December 31, 2001, $74 million in 2000 and $155 million in 1999.

Realized investment gains, net of losses, also includes impairments on fixed income and equity assets, which we recognize on an ongoing basis. The level of impairments generally reflects economic conditions, and is expected to increase when economic conditions worsen and to decrease when economic conditions improve.

We use derivative contracts to hedge the risk that changes in interest rates or foreign currency exchange rates will affect the market value of certain investments. The vast majority of these derivative contracts do not qualify for hedge accounting and, consequently, we recognize the changes in fair value of such contracts from period to period in current earnings, although we do not necessarily treat the underlying assets the same way. Accordingly, our hedging activities contribute significantly to fluctuations in realized investment gains and losses.

The comparisons below discuss realized investment gains net of losses and related charges. These charges relate to policyholder dividends, DAC, and reserves for future policy benefits. Net realized investment gains is one of the elements that we consider in establishing the domestic dividend scale and in providing for dividends to Gibraltar Life policyholders, and the related charge for dividends to policyholders represents the estimated portion of our expense charge for policyholder dividends that is attributable to net realized investment gains that we consider in determining our dividend scale and the Gibraltar Life dividends. See "—Results of Operations for Financial Services Businesses by Division and Closed Block Business" below. We amortize deferred policy acquisition costs for interest sensitive products based on estimated gross profits, which include net realized investment gains on the underlying invested assets, and the related charge for amortization of deferred policy acquisition costs represents the amortization related to net realized investment gains. We adjust the reserves for some of our policies when cash flows related to these policies are affected by net realized investment gains, and the related charge for reserves for future policy benefits represents that adjustment. The changes in these related charges from one period to another may be disproportionate to the changes in realized investment gains, net of losses, because the indicated reserve adjustments relate to realized investment gains, but not losses, evaluated over several periods, and because realized investment gains and losses are reflected in the dividend scale over a number of years.

2001 to 2000 Annual Comparison. For the Financial Services Businesses, realized investment gains, net of losses and related charges, increased $272 million, from a net loss of $408 million in 2000 to a net loss of $136 million in 2001. The net realized investment loss of the Financial Services Businesses for 2001 reflected impairments recognized of $557 million, and $196 million of losses on disposal of substantially all of the Enron holdings of the Financial Services Businesses. For the Closed Block Business, realized investment gains, net of losses and related charges, declined $701 million, from a net loss of $354 million in 2000 to a net loss of $1.055 billion in 2001. The net realized investment loss of the Closed Block Business for 2001 reflected impairments recognized of $475 million, and $160 million of losses on disposal of substantially all of the Enron holdings of the Closed Block Business.

On a consolidated basis, realized investment gains, net of losses and related charges, declined $429 million, from a net loss of $762 million in 2000 to a net loss of $1.191 billion in 2001. Realized investment losses, net of gains but excluding related charges, declined $417 million, from a net loss of $288 million in 2000 to a net loss of $705 million in 2001. Charges related to net realized investment gains and losses amounted to $474 million in 2000 and $486 million in 2001. These charges did not change proportionately with the change in realized investment gains, net of losses, from 2000 to 2001 for the reasons described above.

On a consolidated basis, we realized net losses of $639 million on fixed maturity investments in 2001, compared to net losses of $ 1.066 billion in 2000. During 2001, we recognized impairments on fixed maturities totaling $777 million and realized additional losses of $356 million on the sale of substantially all of our Enron holdings. These impairments and losses were partially offset by realized gains of $494 million primarily from sales and prepayments of fixed maturities in an environment of lower interest rates than when the securities were purchased. The net losses in 2000 came primarily from fixed maturity investment sales in an environment of higher interest rates than those when the securities were purchased as well as impairments we recorded on fixed maturity investments totaling $540 million. The effect of economic and market conditions is uncertain and could result in additional impairments. We realized net losses on equity securities of $245 million in 2001, compared to net gains of $450 million in 2000, as we benefited in 2000 from more favorable equity market conditions, particularly during the early part of the year, and we disposed of appreciated equity securities as part of a portfolio rebalancing program. We recorded net investment gains on derivatives of $126 million in 2001 and $165 million in 2000.

2000 to 1999 Annual Comparison. For the Financial Services Businesses, realized investment gains, net of losses and related charges, declined $852 million from a net gain of $444 million in 1999 to a net loss of $408 million in 2000. For the Closed Block Business, realized investment gains, net of losses and related charges, declined $382 million, from a net gain of $28 million in 1999 to a net loss of $354 million in 2000.

On a consolidated basis, realized investment gains, net of losses and related charges, declined $1.234 billion, from a net gain of $472 million in 1999 to a net loss of $762 million in 2000. Realized investment gains, net of losses but excluding related charges, declined $1.212 billion, from a net gain of $924 million in 1999 to a net loss of $288 million in 2000. Charges related to net realized investment gains and losses were essentially unchanged, amounting to $452 million in 1999 and $474 million in 2000. These charges did not change proportionately with the change in realized investment gains, net of losses, in 2000 from 1999 for the reasons described above.

We realized losses of $1.066 billion on fixed maturity investments in 2000 and $557 million in 1999. These net realized losses reflected the impact of fixed maturity investment sales in environments of higher interest rates than those when the securities were purchased. The $509 million increase in fixed maturity realized losses in 2000 from 1999 came primarily from a portfolio strategy we implemented to sell securities with lower investment income yields underlying some of our long-duration products in the Other Employee Benefits segment and in our debt-financed corporate investment portfolio, reinvesting the proceeds in higher yielding securities, and from increased impairments in 2000. We recognized impairments on fixed maturity investments of $540 million in 2000, primarily on publicly traded high yield and other corporate bonds, compared to $266 million in 1999. We realized net gains on sales of equity securities of $450 million in 2000, compared to $223 million in 1999. We realized net gains from disposals of direct real estate and real estate related joint ventures of $149 million in 2000 compared to $703 million in 1999, reflecting several major transactions that closed in 1999. We recorded net investment gains of $165 million on derivatives during 2000, compared to net gains of $305 million in 1999.

Sales Practices Remedies and Costs
As of December 31, 2001, we have provided $4.405 billion before tax, equivalent to $2.850 billion after tax, for both the cost of remedies to be provided to life insurance policyholders under the remediation process required under the principal sales practices class action settlement to which we are a party and additional sales practices costs and expenses. We believe we are fully reserved and we have not recorded any incremental charges since 1999. These costs include estimated administrative costs related to the remediation program and its accompanying alternative dispute resolution process, regulatory fines, penalties and related payments, litigation costs and settlements, including settlements associated with the resolution of claims of deceptive sales practices asserted by policyholders who elected to "opt-out" of the class action settlement and litigate their claims against us separately, as well as other associated fees and expenses, which we refer to in the aggregate as additional sales practices costs.

Charges associated with the cost of remedying policyholder claims and additional sales practices costs have been adjusted from year to year, beginning in 1996. No additional net charges have been recorded since 1999. The charges from year to year primarily reflected the increased availability over time of more specific information about the number of policyholder claims received and remedied, the accrued interest associated with claim relief, other factors affecting both the cost of remedies and the cost to us of administering the remediation program, and the cost of resolving "opt out" litigation as described above. See Note 21 to the Consolidated Financial Statements for a further description of these charges.

The charges related to our estimated costs of sales practices remedies and additional sales practices costs and the related liability balances at the dates indicated are shown below.

See Note 21 to the Consolidated Financial Statements for a description of the life insurance sales practices litigation.

While a portion of the sales practices remedies have been in the form of policy credits or enhancements, the major portion of the total cost for sales practices remedies and additional sales practices costs have resulted in cash disbursements. The cash outflows from these disbursements have reduced our invested assets and consequently have reduced our investment income. We included the investment income from the assets used to satisfy the sales practices remedies and additional sales practices costs prior to their disbursement in our adjusted operating income for Corporate and Other operations. The $4.4 billion of cash disbursements do not include the cash flow from surrenders associated with the implementation of the sales practices remediation program, which are discussed under "—Results of Operations for Financial Services Businesses by Division and Closed Business—Closed Block Business—Policy Surrender Experience.

Divested Businesses
Our income from continuing operations includes results from several businesses that we have divested but that under generally accepted accounting principles do not qualify for "discontinued operations" treatment in our income statement. Our results from divested businesses primarily relate to the former lead-managed equity underwriting for corporate issuers and institutional fixed income businesses of Prudential Securities and the operations of Gibraltar Casualty Company, a commercial property and casualty insurer that we sold in September 2000, as well as obligations we retained or agreed to in the transactions to sell our other divested businesses. The lead-managed equity underwriting for corporate issuers and institutional fixed income businesses of Prudential Securities recorded pre-tax losses of $159 million in the year ended December 31, 2001, and $620 million in 2000, and pre-tax income of $23 million in 1999. The losses in 2001 came primarily from deterioration in the value of collateralized receivables that we are in the process of liquidating, which are related to these businesses, and wind-down costs. The losses from these operations in 2000 came primarily from charges of $476 million associated with our termination and wind-down of these activities. Gibraltar Casualty recorded pre-tax losses of $7 million in 2000 and $72 million in 1999. The 1999 losses are attributable to increased reserves for environmental and asbestos-related claims resulting primarily from an increase in the number of lawsuits being filed against manufacturers of asbestos-related products. The remainder of our results from divested businesses are attributable to our remaining obligations with respect to our divested residential mortgage banking business, a benefits plan administration business we sold in 1998, and a Canadian life insurance subsidiary that we sold in May 2000.

Demutualization Costs and Expenses
We incurred costs and expenses related to demutualization totaling $588 million in the year ended December 31, 2001, including $340 million of demutualization consideration paid to our former Canadian branch policyholders, $143 million in 2000, and $75 million in 1999. These costs and expenses are reported separately in our consolidated income statements within income from continuing operations before income taxes. Demutualization expenses consist primarily of the costs of engaging independent accounting, actuarial, investment banking, legal and other consultants to advise us and insurance regulators in the demutualization process and related matters as well as printing and postage for communication with policyholders.

Taxes
A provision of federal tax law applicable to mutual life insurance companies has resulted in significant fluctuations in our effective tax rate. This tax law requires adjustment to the deductible portion of policyholder dividends based on a complex multi-year formula that compares the financial accounting earnings rates of mutual life insurance companies with those of stock life insurers. The actual rate to be applied to a particular tax year is determined by the IRS up to two years after the end of the tax year. Accordingly, for periods prior to our demutualization, we were required to estimate the current year's rate in determining our tax provision for the current year for accounting purposes. When the actual rate was announced by the IRS, we recognized any difference between our estimated rate and the IRS's actual rate in that year. We are no longer subject to this tax after the demutualization. The impact of this tax law as reflected in reported results, including the current year estimate and adjustment of prior year estimates, constitutes the primary reason for the difference between our reported effective tax rates and the statutory rate of 35%. See Note 17 to the Consolidated Financial Statements.

We recorded a net income tax benefit of $57 million in 2001 and an income tax provision of $406 million in 2000. The income tax benefit in 2001 represented 25% of our loss from continuing operations before income taxes, while the income tax provision in 2000 represented 56% of that year's income from continuing operations before income taxes. The net income tax benefit in 2001 was primarily due to a $200 million reduction of the estimated liability for the mutual life insurance company tax, while the income tax provision in 2000 reflected a $100 million provision for this tax. The disparity between our effective tax rates in 2001 and 2000 and the application of the corporate income tax rate of 35% to our income or loss from continuing operations before income taxes is primarily a result of the mutual life insurance company tax and the inclusion of demutualization costs and expenses within income or loss from continuing operations before income taxes.

Our income tax provisions amounted to $406 million for 2000 and $1.042 billion for 1999. The income tax provisions represented 56% of income from continuing operations before income taxes in 2000 and 46% of income from continuing operations before income taxes in 1999. This increase in the effective rate was due primarily to the mutual life insurance company tax discussed above and an increase in demutualization expenses.

Discontinued Operations
In December 1998, we entered into a definitive agreement to sell our healthcare operations as described in Note 3 to the Consolidated Financial Statements. The sale was completed in August 1999. Net losses from these operations, after related income tax benefits, were $521 million in 1998, including a $223 million loss on disposal. We recognized an additional loss on disposal of these operations during 1999 amounting to $400 million after related tax benefits. Higher than anticipated operating losses prior to the closing date, resulting principally from adverse claims experience, and the impact of this experience on our evaluation of our obligations under our agreement to make payments to the purchaser of our healthcare operations if the medical loss ratio exceeds specified levels, caused the additional loss. In 2000, upon completion of the period covered by that agreement and comparing other costs we incurred related to the healthcare disposal to those estimated in 1998 and 1999, we reduced the loss on disposal by $77 million, after related income taxes. In 2001, we further reduced the loss on disposal by $16 million, after related income taxes, upon completing the negotiation of the final medical loss ratio settlement in December 2001. While we believe that, as of December 31, 2001, we have adequately reserved in all material respects for remaining costs and liabilities associated with our healthcare business, we might incur additional charges that might be material to our results of operations.

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