Prudential 2002 Annual Report Download - page 82
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Please find page 82 of the 2002 Prudential annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.We manage our exposure to equity price risk relating to our general account primarily by seeking to match
the risk profile of equity investments against risk-adjusted equity market benchmarks. We measure benchmark
risk levels in terms of price volatility in relation to the market in general.
The sources of our exposure to market risk can be divided into two categories, “other than trading” activities
conducted primarily in our insurance, annuity and guaranteed products operations, and “trading” activities
conducted primarily in our securities operations. As part of our management of both “other than trading” and
“trading” market risks, we use a variety of risk management tools and techniques. These include sensitivity and
Value-at-Risk (“VaR”) measures, position and other limits based on type of risk, and various hedging methods.
Other Than Trading Activities
We hold the majority of our assets for “other than trading” activities in our segments that offer insurance,
annuities and guaranteed products. We incorporate asset/liability management techniques and other risk
management policies and limits into the process of investing our assets. We use derivatives for hedging purposes
in the asset/liability management process.
Insurance, Annuities and Guaranteed Products Asset/Liability Management
We seek to maintain interest rate and equity exposures within established ranges, which we periodically
adjust based on market conditions and the design of related products sold to customers. Our risk managers
establish investment risk limits for exposures to any issuer, geographic region, type of security or industry sector
and oversee efforts to manage risk within policy constraints set by management and approved by the Board of
Directors.
We use duration and convexity analyses to measure price sensitivity to interest rate changes. Duration
measures the relative sensitivity of the fair value of a financial instrument to changes in interest rates. Convexity
measures the rate of change of duration with respect to changes in interest rates. We seek to manage our interest
rate exposure by legal entity by matching the relative sensitivity of asset and liability values to interest rate
changes, or controlling “duration mismatch” of assets and liabilities. We have target duration mismatch
constraints for each entity. As of December 31, 2002 and 2001, the difference between the pre-tax duration of
assets and the target duration of liabilities in our duration managed portfolios was within our constraint limits. We
consider risk-based capital implications in our asset/liability management strategies.
We also perform portfolio stress testing as part of our regulatory cash flow testing. In this testing, we
evaluate the impact of altering our interest-sensitive assumptions under various moderately adverse interest rate
environments. These interest-sensitive assumptions relate to the timing and amount of redemptions and
prepayments of fixed-income securities and lapses and surrenders of insurance products. We evaluate any
shortfalls that this cash flow testing reveals to determine if we need to increase statutory reserves or adjust
portfolio management strategies.
Market Risk Related to Interest Rates
Our “other than trading” assets that subject us to interest rate risk include fixed maturity securities,
commercial loans and policy loans. In the aggregate, the carrying value of these assets represented 70% of our
consolidated assets, other than assets that we held in separate accounts, as of December 31, 2002 and 64% as of
December 31, 2001.
With respect to “other than trading” liabilities, we are exposed to interest rate risk through policyholder
account balances relating to interest-sensitive life insurance, annuity and investment-type contracts and through
outstanding short-term and long-term debt.
Prudential Financial 2002 Annual Report 81