Prudential 2012 Annual Report Download - page 44

As a result of this intercompany arrangement, our International Insurance segment’s results for 2012 and 2011 reflect the impact of
translating yen-denominated earnings at fixed currency exchange rates of 85 and 92 yen per U.S. dollar, respectively, and 1180 and 1190
Korean won per U.S. dollar, respectively. Results for 2013 will reflect the impact of translating yen and Korean won-denominated earnings
at fixed currency exchange rates of 80 yen per U.S. dollar and 1160 Korean won per U.S. dollar.
Results of Corporate and Other operations include any differences between the translation adjustments recorded by the segment at the
fixed currency exchange rate versus the actual average rate during the period, and the gains or losses recorded from the forward currency
contracts that settled during the period, which include the impact of any over or under hedging of actual earnings that differ from projected
earnings. The table below presents, for the periods indicated, the increase (decrease) to revenues and adjusted operating income for the
International Insurance segment and for Corporate and Other operations, reflecting the impact of this intercompany arrangement.
Year ended December 31,
2012 2011 2010
(in millions)
International Insurance Segment:
Impact of intercompany arrangement(1) ............................................................... $(92) $(178) $(102)
Corporate and Other operations:
Impact of intercompany arrangement(1) ............................................................... 92 178 102
Settlement losses on forward currency contracts ........................................................ (72) (137) (97)
Net benefit to Corporate and Other operations ...................................................... 20 41 5
Net impact on consolidated revenues and adjusted operating income ............................................ $(72) $(137) $ (97)
(1) Represents the difference between non-U.S. dollar-denominated earnings translated on the basis of weighted average monthly currency exchange rates
versus fixed currency exchange rates determined in connection with the forward currency hedging program.
As of December 31, 2012 and 2011, the notional amounts of these forward currency contracts were $3.4 billion and $3.0 billion,
respectively, of which $2.9 billion and $2.5 billion, respectively, were related to our Japanese insurance operations.
Dual currency and synthetic dual currency investments hedging program
In addition, our Japanese insurance operations hold dual currency investments in the form of fixed maturities and loans. The principal of
these dual currency investments is yen-denominated while the related interest income is U.S. dollar-denominated. These investments are the
economic equivalent of exchanging what would otherwise be fixed streams of yen-denominated interest income for fixed streams of
U.S. dollar-denominated interest income. Our Japanese insurance operations also hold yen-denominated investments that have been coupled
with cross-currency coupon swap agreements, creating synthetic dual currency investments. The yen/U.S. dollar exchange rate is effectively
fixed, as we are obligated in future periods to exchange fixed amounts of yen interest payments generated by the yen-denominated
investments for fixed amounts of U.S. dollar interest payments at the yen/U.S. dollar exchange rates specified by the cross-currency coupon
swap agreements. As of December 31, 2012 and 2011, the notional amount of these investments was ¥235 billion, or $2.2 billion, and ¥280
billion, or $2.5 billion, respectively, based upon the foreign currency exchange rates applicable at the time these investments were acquired.
The table below sets forth the fair value of these instruments as reflected on our balance sheet for the periods indicated.
December 31,
2012 2011
(in millions)
Cross-currency coupon swap agreements ........................................................................... $ (7) $(105)
Foreign exchange component of interest on dual currency investments ................................................... (92) (128)
Total ................................................................................................... $(99) $(233)
U.S. GAAP earnings impact of products denominated in non-local currencies
Our international insurance operations primarily offer products denominated in local currency. However, several of our international
insurance operations, most notably our Japanese operations, also offer products denominated in non-local currencies, primarily comprised
of U.S. and Australian dollar-denominated products. The non-yen denominated insurance liabilities related to these products are supported
by investments denominated in corresponding currencies, including a significant portion designated as available-for-sale. While the impact
from foreign currency exchange rate movements on these non-yen denominated assets and liabilities is economically matched, 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 U.S. GAAP earnings. For example, unrealized gains and losses on available-for-sale investments, including those
arising from foreign currency exchange rate movements, are recorded in AOCI, whereas the non-yen denominated liabilities are
remeasured for foreign currency exchange rate movements, and the related changes in value are recorded in earnings within “Asset
management fees and other income.” Investments designated as held-to-maturity under U.S. GAAP are recorded at amortized cost on the
balance sheet, but are remeasured for foreign currency exchange rate movements, with the related change in value recorded in earnings
within “Asset management fees and other income.” Due to this non-economic volatility that is reflected in U.S. GAAP earnings, the gains
and losses resulting from the remeasurement of these non-yen denominated liabilities, and certain related non-yen denominated assets, are
excluded from adjusted operating income and included in “Realized investment gains (losses), net, and related adjustments.” For the years
ended December 31, 2012, 2011 and 2010, “Realized investment gains (losses), net, and related adjustments” includes net losses of $1,570
million, net gains of $807 million, and net gains of $121 million, respectively, reflecting the remeasurement of these non-yen denominated
insurance liabilities, which are presented in the table below, and the remeasurement of certain related non-yen denominated assets.
We continue to expect volatility in U.S. GAAP earnings resulting from the remeasurement mismatch described above. For example,
based on the December 31, 2012 non-yen denominated balances subject to remeasurement (including those presented in the table below), if
we applied a hypothetical 5% depreciation in value of the yen relative to the U.S. and Australian dollar, we estimate this would result in net
losses of approximately $1.2 billion reflected in U.S. GAAP earnings. These net losses would largely be offset by a corresponding increase
in unrealized gains in AOCI. Conversely, a 5% appreciation in value of the yen relative to these currencies would have an equal but
opposite effect.
42 Prudential Financial, Inc. 2012 Annual Report