Prudential 2015 Annual Report Download - page 209

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
For effective net investment hedges, the amounts, before applicable taxes, recorded in the cumulative translation adjustment account
within AOCI were $541 million in 2015, $501 million in 2014 and $356 million in 2013.
Credit Derivatives
Credit derivatives, where the Company has written credit protection on a single name reference, had outstanding notional amounts of
$106 million and $5 million as of December 31, 2015 and 2014, respectively. These credit derivatives are reported at fair value as a
liability of $3 million and an asset of less than $1 million, as of December 31, 2015 and 2014, respectively. As of December 31, 2015,
these credit derivatives’ notionals had the following NAIC ratings: $37 million in NAIC 1, $60 million in NAIC 2, $4 million in NAIC 3,
$2 million in NAIC 5 and $3 million in NAIC 6. The Company has also written credit protection on certain index references with notional
amounts of $701 million and $1,544 million, reported at fair value as a liability of $24 million and $2 million as of December 31, 2015 and
December 31, 2014, respectively. As of December 31, 2015, these credit derivatives’ notionals had the following NAIC ratings: $450
million in NAIC 1 and $251 million in NAIC 5. As of December 31, 2014, these credit derivatives’ notionals had a designation of NAIC 3.
NAIC designations are based on the lowest rated single name reference included in the index.
The Company’s maximum amount at risk under these credit derivatives equals the aforementioned notional amounts and assumes the
value of the underlying referenced securities become worthless. These single name credit derivatives have maturities of less than 5 years,
while the credit protection on the index references have maturities of less than 42 years. This excludes a credit derivative related to surplus
notes issued by a subsidiary of Prudential Insurance.
The Company also entered into a credit derivative that will require the Company to make certain payments in the event of
deterioration in the value of the surplus notes issued by a subsidiary of Prudential Insurance. The notional amount of this credit derivative
is $500 million and the fair value as of December 31, 2015 and 2014, was a liability of $15 million and $4 million, respectively. No
collateral was pledged in either period.
In addition to writing credit protection, the Company has purchased credit protection using credit derivatives in order to hedge specific
credit exposures in the Company’s investment portfolio. As of December 31, 2015 and 2014, the Company had $532 million and $573
million of outstanding notional amounts reported at fair value as a liability of $8 million and $17 million, respectively.
Counterparty Credit Risk
The Company is exposed to credit-related losses in the event of non-performance by counterparties to financial derivative transactions.
The Company manages credit risk by entering into derivative transactions with highly rated major international financial institutions and
other creditworthy counterparties, and by obtaining collateral, such as cash and securities, when appropriate. Additionally, limits are set on
single party credit exposures which are subject to periodic management review.
The credit exposure of the Company’s OTC derivative transactions is represented by the contracts with a positive fair value at the
reporting date. To reduce credit exposures, the Company seeks to (i) enter into OTC derivative transactions pursuant to master agreements
that provide for a netting of payments and receipts with a single counterparty and (ii) enter into agreements that allow the use of credit
support annexes, which are bilateral rating-sensitive agreements that require collateral postings at established threshold levels. Cleared
derivatives are transactions between the Company and a counterparty where the transactions are cleared through a clearinghouse, such that
each derivative counterparty is only exposed to the default of the clearinghouse. These cleared transactions require initial and daily
variation margin collateral postings and include certain interest rate swaps and credit default swaps entered into on or after June 10, 2013,
related to guidelines under Dodd-Frank. The Company also enters into exchange-traded futures and certain options transactions through
regulated exchanges and these transactions are settled on a daily basis, thereby reducing credit risk exposure in the event of non-
performance by counterparties to such financial instruments.
Under fair value measurements, the Company incorporates the market’s perception of its own and the counterparty’s NPR in
determining the fair value of the portion of its OTC derivative assets and liabilities that are uncollateralized. Credit spreads are applied to the
derivative fair values on a net basis by counterparty. To reflect the Company’s own credit spread a proxy based on relevant debt spreads is
applied to OTC derivative net liability positions. Similarly, the Company’s counterparty’s credit spread is applied to OTC derivative net asset
positions.
Certain of the Company’s derivative agreements with some of its counterparties contain credit-rating related triggers. If the
Company’s credit rating were to fall below a certain level, the counterparties to the derivative instruments could request termination at the
then fair value of the derivative or demand immediate full collateralization on derivative instruments in net liability positions. As of
December 31, 2015, there were no net liability derivative positions with counterparties with credit-risk-related contingent features. As such,
the Company has not posted any collateral related to these positions and the Company would not be required to post any additional
collateral to the counterparties if the credit-risk-related contingent features underlying these agreements had been triggered as of
December 31, 2015.
Prudential Financial, Inc. 2015 Annual Report 207