Prudential 2012 Annual Report Download - page 65

• for certain portfolios, optimizing total return, including both investment income yield and capital appreciation, within risk
constraints over time, while managing the market risk exposures associated with the corresponding product liabilities.
We pursue our objective to optimize investment income yield for the Financial Services Businesses over time through: (1) the
investment of net operating cash flow, including new product premium inflows, and proceeds from investment sales, repayments and
prepayments, into investments with attractive risk-adjusted yields, and (2) where appropriate, the sale of lower yielding investments, either
to meet various cash flow needs or to manage the portfolio’s risk exposure profile with respect to duration, credit, currency and other risk
factors, while considering the impact on taxes and capital.
The primary investment objectives of the Closed Block Business include:
• providing for the reasonable dividend expectations of the participating policyholders within the Closed Block Business and the
Class B shareholders; and
• optimizing total return, including both investment income yield and capital appreciation, within risk constraints, while managing the
market risk exposures associated with the major products in the Closed Block Business.
Our portfolio management approach, while emphasizing our investment income yield and asset/liability risk management objectives,
also takes into account the capital and tax implications of portfolio activity, our assertions regarding our ability and intent to hold equity
securities to recovery, and our lack of any intention or requirement to sell debt securities before anticipated recovery. For a further
discussion of our policies regarding other-than-temporary impairments, including our assertions regarding our ability and intent to hold
equity securities to recovery and any intention or requirement to sell debt securities before anticipated recovery, see “—Fixed Maturity
Securities—Other-than-Temporary Impairments of Fixed Maturity Securities” and “—Equity Securities—Other-than-Temporary
Impairments of Equity Securities,” below.
Management of Investments
The Investment Committee of our Board of Directors oversees our proprietary investments, including our general account portfolios.
It also regularly reviews performance and risk positions. Our Chief Investment Officer Organization (“CIO Organization”) works with our
Risk Management group to develop the investment policies for the general account portfolios of our domestic and international insurance
subsidiaries, and directs and oversees management of the general account portfolios within risk limits and exposure ranges approved
annually by the Investment Committee.
The CIO Organization, including related functions within our insurance subsidiaries, works closely with product actuaries and Risk
Management to understand the characteristics of our products and their associated market risk exposures. This information is incorporated
into the development of target asset portfolios that hedge market risk exposures associated with the liability characteristics and establish
investment risk exposures, within tolerances proscribed by Prudential’s investment risk limits, on which we expect to earn an attractive
risk-adjusted return. We develop asset strategies for specific classes of product liabilities and attributed or accumulated surplus, each with
distinct risk characteristics. Market risk exposures associated with the liabilities include interest rate risk which is addressed through the
duration characteristics of the target asset mix, and currency risk which is addressed by the currency profile of the target asset mix. In
certain of our smaller markets, outside of the U.S. and Japan, capital markets limitations hinder our ability to hedge interest rate exposure to
the same extent we do for our U.S. and Japan businesses and lead us to accept a higher degree of interest rate risk in these smaller
portfolios. General account portfolios typically include allocations to credit and other investment risks as a means to enhance investment
yields and returns over time.
Most of our products can be categorized into the following three classes:
• interest-crediting products for which the rates credited to customers are periodically adjusted to reflect market and competitive
forces and actual investment experience, such as fixed annuities and universal life insurance;
• participating individual and experience-rated group products in which customers participate in actual investment and business
results through annual dividends, interest or return of premium; and
• guaranteed products for which there are price or rate guarantees for the life of the contract, such as traditional whole life and
endowment products, guaranteed investment contracts and funding agreements.
Our total investment portfolio is composed of a number of operating portfolios. Each operating portfolio backs a specific set of
liabilities and the portfolios have a target asset mix that supports the liability characteristics, including duration, cash flow, liquidity needs
and other criteria. As of December 31, 2012, the average duration of our general account investment portfolios attributable to the domestic
Financial Services Businesses, including the impact of derivatives, is between 5 and 6 years. As of December 31, 2012, the average
duration of our general account portfolios attributable to our Japanese insurance operations, including the impact of derivatives, is
approximately 10 years, which represents a blend of yen-denominated and U.S. and Australian dollar-denominated investments, which
have distinct average durations. Our asset/liability management process has enabled us to successfully manage our portfolios through
several market cycles.
We implement our portfolio strategies primarily through investment in a broad range of fixed income assets, including government
and agency securities, public and private corporate bonds and structured securities, and commercial mortgage loans. In addition, we hold
small allocations to alternative assets and other equities.
We manage our public fixed maturity portfolio to a risk profile directed or overseen by the CIO Organization and Risk Management
groups and to a profile that also reflects the local market environments impacting both our domestic and international insurance portfolios.
The return that we earn on the portfolio will be reflected both as investment income and also as realized gains or losses on investments.
We use privately-placed corporate debt securities and commercial mortgage loans, which consist of well-underwritten mortgages on
diversified properties in terms of geography, property type and borrowers, to enhance the yield on our portfolio and to improve the overall
diversification of the portfolios. Private placements typically offer enhanced yields due to an illiquidity premium and generally offer
enhanced credit protection in the form of covenants. Our origination capability offers the opportunity to lead transactions and gives us the
opportunity for better terms, including covenants and call protection, and to take advantage of innovative deal structures.
Derivative strategies are employed in the context of our risk management framework to enhance our ability to manage interest rate and
currency risk exposures of the asset portfolio relative to the liabilities and to manage credit and equity positions in the investment
portfolios. For a discussion of our risk management process see “Quantitative and Qualitative Disclosures About Market Risk” below.
Prudential Financial, Inc. 2012 Annual Report 63