Prudential 2012 Annual Report Download - page 43

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 and Korea. 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 utilize a yen hedging strategy that calibrates the level of hedges to preserve the relative contribution of our yen-based business to
the Company’s overall return on equity. Our hedges include a variety of instruments, including U.S. dollar-denominated assets held locally
by our Japanese insurance subsidiaries 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.
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 shareholder return on equity from our Japanese insurance subsidiaries for the periods indicated.
December 31,
2012 2011
(in billions)
Instruments hedging foreign currency exchange rate exposure on U.S. dollar-equivalent earnings:
Forward currency hedging program(1) ......................................................................... $ 2.9 $ 2.5
Dual currency and synthetic dual currency investments(2) ......................................................... 0.9 1.0
3.8 3.5
Instruments hedging foreign currency exchange rate exposure on U.S. dollar-equivalent equity:
Available-for-sale U.S. dollar-denominated investments, at amortized cost ............................................ 7.0 6.8
Held-to-maturity U.S. dollar-denominated investments, at amortized cost ............................................. 0.3 0.3
Other ................................................................................................... 0.1 0.1
U.S. dollar-denominated assets held in yen-based entities(3) ........................................................... 7.4 7.2
Yen-denominated liabilities held in U.S. dollar-based entities(4) ........................................................ 0.8 0.8
8.2 8.0
Total hedges ..................................................................................................... $12.0 $11.5
(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 $26.8 billion and $23.7 billion as of December 31, 2012 and 2011, respectively, of U.S. dollar assets supporting U.S. dollar liabilities related
to U.S. dollar-denominated products issued by our Japanese insurance operations.
(4) The yen-denominated liabilities are reported in Corporate and Other operations.
The U.S. dollar-denominated investments that hedge the U.S. dollar-equivalent shareholder return on equity from our Japanese
insurance operations are recorded on the books of yen-based entities and, as a result, foreign currency exchange rate movements will
impact their value on the local books of our yen-based Japanese insurance entities. We seek to mitigate the risk that future unfavorable
foreign currency exchange rate movements will decrease the value of these U.S. dollar-denominated investments on the local books of our
yen-based Japanese insurance entities and therefore negatively impact their equity and regulatory solvency margins by employing internal
hedging strategies between a subsidiary of Prudential Financial and these yen-based entities. These internal hedging strategies have the
economic effect of moving the change in value of these U.S. dollar-denominated investments due to foreign currency exchange rate
movements from our Japanese yen-based entities to our U.S. dollar-based entities. See “—Liquidity and Capital
Resources—Liquidity—Liquidity associated with other activities—Foreign exchange hedging activities” for a discussion of our internal
hedging strategies.
These U.S. dollar-denominated investments also pay a coupon which is generally higher than what a similar yen-denominated
investment would pay. The incremental impact of this higher yield on 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 “—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 reflect the impact of an intercompany arrangement with Corporate and
Other operations pursuant to which the segment’s non-U.S. dollar-denominated earnings 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 for certain currencies in exchange for U.S. dollars at
specified exchange rates. The maturities of these contracts correspond with the future periods (typically on a three-year rolling basis) in
which the identified non-U.S. dollar-denominated earnings are expected to be generated. In establishing the level of non-U.S. dollar-
denominated earnings that will be hedged through this program, we exclude the anticipated level of U.S. dollar-denominated earnings that
will be generated by dual currency and synthetic dual currency investments, as well as the anticipated level of non-yen denominated
earnings that will be generated by non-yen denominated products and investments, both of which are discussed in greater detail below.
Prudential Financial, Inc. 2012 Annual Report 41