Prudential 2012 Annual Report Download - page 103

As of December 31, 2012 As of December 31, 2011(5)
Notional
Fair
Value
Hypothetical
Change in Fair
Value Notional
Fair
Value
Hypothetical
Change in Fair
Value
(in millions)
Financial assets with interest rate risk:
Fixed maturities(1) ........................................ $326,489 $(27,238) $ 279,099 $(21,623)
Commercial mortgage and other loans ......................... 39,716 (1,658) 37,740 (1,520)
Policy loans .............................................. 14,592 (902) 14,858 (987)
Derivatives:
Swaps .............................................. $132,661 3,766 (4,818) $118,044 4,184 (3,460)
Futures ............................................. 13,267 (166) 21 8,306 151 (88)
Options ............................................. 68,099 1,330 (188) 30,506 1,466 (416)
Forwards ............................................ 15,937 (60) (31) 19,120 (152) (35)
Synthetic GICs ....................................... 65,403 6 (2) 46,844 4 (2)
Variable annuity and other living benefit feature embedded
derivatives(2) ...................................... (3,348) 3,295 (2,886) 2,015
Financial liabilities with interest rate risk(3):
Short-term and long-term debt ............................... (30,003) 2,473 (28,174) 2,223
Limited recourse notes issued by consolidated VIEs(4) ............ (224) 0 (493) 0
Investment contracts ....................................... (104,200) 3,730 (103,184) 3,543
Bank customer liabilities ................................... 0 0 (1,745) 12
Net estimated potential loss ............................. $(25,318) $(20,338)
(1) Includes fixed maturities classified as “trading account assets supporting insurance liabilities” and other fixed maturities classified as trading securities
under U.S. GAAP, but are held for “other than trading” activities in our segments that offer insurance, retirement and annuities products.
(2) Reflects only the gross change on the embedded derivatives, and excludes any offsetting impact of derivative instruments purchased to hedge such
changes.
(3) Excludes approximately $249 billion and $203 billion as of December 31, 2012 and December 31, 2011, respectively, of insurance reserve and deposit
liabilities which are not considered financial liabilities. We believe that the interest rate sensitivities of these insurance liabilities would serve as an offset
to the net interest rate risk of the financial assets and liabilities, including investment contracts.
(4) See Note 5 to the Consolidated Financial Statements for additional information regarding consolidated variable interest entities (VIEs).
(5) Prior periods have been restated to conform to current period presentation.
Our net estimated potential loss in fair value as of December 31, 2012 increased $4,980 million from December 31, 2011, primarily
reflecting an increase in our fixed maturity securities portfolio in 2012, driven by inflows related to two significant pension risk transfer
transactions in our Retirement segment, in which we received approximately $31 billion of fixed maturity securities. The increase was also
driven by reinvestment of net investment income and a net increase in fair value driven by a decrease in interest rates. For a discussion of
changes in derivatives, see “Derivatives” below.
Under U.S. GAAP, the fair value of the embedded derivatives for certain variable annuity and other living benefit features, reflected in
the table above, includes the impact of the market’s perception of our own non-performance risk (“NPR”). The additional credit spread
over LIBOR rates incorporated into the discount rate as of December 31, 2012 to reflect NPR in the valuation of these embedded
derivatives ranged from 20 to 160 basis points. The following table provides a demonstration of the sensitivity of these embedded
derivatives to our NPR credit spread by quantifying the adjustments that would be required assuming both a 50 basis point parallel increase
and decrease in our NPR credit spreads. While the information below is for illustrative purposes only and does not reflect our expectations
regarding our credit spreads, it is a near-term, reasonably possible change that illustrates the potential impact of such a change. This
information considers only the direct effect of changes in our credit spread on operating results due to the change in these embedded
derivatives and not changes in any other assumptions such as persistency, utilization and mortality, and also excludes the effect of these
changes on DAC or other balances.
December 31, 2012
(Increase) / Reduction in
Embedded Derivative Liability
(in millions)
Increase in credit spread by 50 basis points .............................................................. $ 933
Decrease in credit spread by 50 basis points .............................................................. $(1,177)
For an additional discussion of our variable annuity optional living benefit guarantees accounted for as embedded derivatives and
related derivatives used to hedge the changes in fair value of these embedded derivatives, see “Market Risk Related to Certain Variable
Annuity Products” below. For additional information about the key estimates and assumptions used in our determination of fair value, see
Note 20 to the Consolidated Financial Statements. For information on the impacts of a sustained low interest rate environment, see
“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Industry Trends—
Impact of a Low Interest Rate Environment.”
Market Risk Related to Equity Prices
We have exposure to equity price risk through our investments in equity securities, equity-based derivatives and certain variable
annuity and other living benefit feature embedded derivatives. Our equity based derivatives primarily hedge the equity price risk embedded
in the living benefit feature embedded derivatives, and are also part of our capital hedging program. Changes in equity prices create risk
that the resulting changes in asset values will differ from the changes in the value of the liabilities relating to the underlying or hedged
products. Additionally, changes in equity prices may impact other items including, but not limited to, the following:
• Asset-based fees earned on assets under management or contractholder account value
Prudential Financial, Inc. 2012 Annual Report 101