Prudential 2011 Annual Report Download - page 52

The operations of our International Insurance Division are subject to currency fluctuations that can materially affect their U.S. dollar-
equivalent earnings from period to period even if earnings on a local currency basis are relatively constant. We enter into forward currency
derivative contracts, and hold “dual currency” and “synthetic dual currency” investments, as part of our strategy to effectively fix the
currency exchange rates for a portion of our prospective non-U.S. dollar-denominated earnings streams, thereby reducing earnings
volatility from foreign currency exchange rate movements. The forward currency hedging program is primarily associated with our
insurance operations in Japan including Star and Edison net of expected integration-related costs, as well as Korea and Taiwan. In addition,
our Japanese insurance operations offer a variety of non-yen denominated products which are supported by investments in corresponding
currencies. While these non-yen denominated assets and liabilities are economically hedged, the accounting for changes in the value of
these assets and liabilities due to changes in foreign currency exchange rate movements differs, resulting in volatility in reported U.S.
GAAP earnings. For further information on the various hedging strategies used to mitigate the risks of foreign currency exchange rate
movements on earnings, see “—Impact of foreign currency exchange rate movements on earnings.”
We also seek to mitigate the impact of foreign currency exchange rate movements on our U.S. dollar-equivalent equity in foreign
subsidiaries through various hedging strategies. In our Japanese insurance subsidiaries, we hedge a portion of the estimated available
economic capital of the business using a variety of instruments, including U.S. dollar-denominated assets financed by the combination of
U.S. GAAP equity and yen-denominated liabilities. We may also hedge using instruments held in our U.S. domiciled entities, such as U.S.
dollar-denominated debt that has been swapped to yen. We are evaluating the hedging strategy related to our Japanese insurance
subsidiaries to consider the Japanese operations’ relative contribution to the Company’s overall return on equity which may result in a
change in the amount of yen exposure we hedge. In our Taiwan insurance operation, the U.S. GAAP equity exposure is mitigated by
holding a variety of instruments, including U.S. dollar-denominated investments. During 2009 and 2010, we terminated our hedges of the
U.S. GAAP equity exposure of our other foreign operations, excluding our Japan and Taiwan insurance operations, due to a variety of
considerations including a desire to limit the potential for cash settlement outflows that would result from strengthening foreign currencies.
For further information on the various instruments used to mitigate the risks of foreign currency exchange rate movements on our U.S.
dollar-equivalent equity in foreign subsidiaries, see “—Impact of foreign currency exchange rate movements on equity.”
The table below presents the aggregate amount of instruments that serve to hedge the impact of foreign currency exchange movements
on our U.S. dollar-equivalent earnings and U.S. dollar-equivalent equity in our Japanese insurance subsidiaries for the periods indicated.
December 31,
2011 2010
(in billions)
Instruments hedging foreign currency exchange rate exposure on U.S. dollar-equivalent earnings:
Forward currency hedging program(1) ............................................................................. $ 2.5 $ 2.5
Dual currency and synthetic dual currency investments(2) ............................................................. 1.0 0.9
3.5 3.4
Instruments hedging foreign currency exchange rate exposure on U.S. dollar-equivalent equity:
U.S. dollar-denominated assets held in yen-based entities(3) ............................................................ 6.9 6.2
Yen-denominated liabilities held in U.S.-based entities(4) ............................................................. 0.8 0.8
7.7 7.0
Total hedges ..................................................................................................... $11.2 $10.4
Total U.S. GAAP equity of Japanese insurance subsidiaries, as adjusted(5) .................................................... $10.7 $ 5.7
(1) Represents the notional amount of forward currency contracts outstanding.
(2) Represents the present value of future cash flows, on a U.S. dollar-denominated basis.
(3) Excludes $24.5 billion and $10.2 billion as of December 31, 2011 and 2010, respectively, of U.S. dollar assets supporting U.S. dollar liabilities related
to U.S. dollar-denominated products issued by our Japanese insurance operations, of which $11.7 billion as of December 31, 2011 supports U.S. dollar-
denominated products issued by Star and Edison.
(4) The yen-denominated liabilities are reported in Corporate and Other operations.
(5) Excludes “Accumulated other comprehensive income (loss)” components of equity and certain other adjustments.
The U.S. dollar-denominated investments that hedge the U.S. GAAP equity exposure in our Japanese insurance operations pay a
coupon, which is reflected within “Net investment income,” and, therefore, included in adjusted operating income, which is generally
higher than what a similar yen-based investment would pay. The incremental impact of this higher yield of our U.S. dollar-denominated
investments, as well as our dual currency and synthetic dual currency investments discussed below, will vary over time, and is dependent
on the duration of the underlying investments, as well as interest rate environments in the U.S. and Japan at the time of the investments. See
“—Realized Investment Gains and Losses and General Account Investments—General Account Investments—Investment Results” for a
discussion of the investment yields generated by our Japanese insurance operations.
Impact of foreign currency exchange rate movements on earnings
Forward currency hedging program
The financial results of our International Insurance segment for all periods presented reflect the impact of an intercompany
arrangement with Corporate and Other operations pursuant to which the segment’s non-U.S. dollar-denominated earnings in certain
countries are translated at fixed currency exchange rates. The fixed rates are determined in connection with a foreign currency income
hedging program designed to mitigate the impact of exchange rate changes on the segment’s U.S. dollar-equivalent earnings. Pursuant to
this program, Corporate and Other operations execute forward currency contracts with third parties to sell the net exposure of projected
earnings from the hedged currency in exchange for U.S. dollars at specified exchange rates. The maturities of these contracts correspond
with the future periods in which the identified non-U.S. dollar-denominated earnings are expected to be generated. In establishing the level
50 Prudential Financial, Inc. 2011 Annual Report