Prudential 2015 Annual Report Download - page 34

We seek to offset the changes in our hedge target by entering into a range of exchange-traded, cleared and over the counter equity and
interest rate derivatives to hedge certain capital market risks present in our hedge target. The instruments include, but are not limited to,
interest rate swaps, swaptions, floors and caps as well as equity options, total return swaps and equity futures. The following table sets forth
the market and notional values of these instruments as of the periods indicated.
As of December 31, 2015 As of December 31, 2014
Equity Interest Rate Equity Interest Rate
Instrument Notional
Market
Value Notional
Market
Value Notional
Market
Value Notional
Market
Value
(in billions)
Futures ............................................ $ 0.1 $0.0 $ 0.8 $0.0 $ 0.2 $ 0.0 $ 0.0 $0.0
Swaps(1) ........................................... 17.2 (0.1) 91.7 6.2 14.5 (0.4) 87.7 5.1
Options ............................................ 5.0 0.0 14.4 0.2 10.4 0.4 25.5 0.5
Total .......................................... $22.3 $(0.1) $106.9 $6.4 $25.1 $ 0.0 $113.2 $5.6
(1) Includes interest rate swaps for which offsetting positions exist in Corporate and Other operations, reflecting the impact of managing interest rate risk
through capital management strategies other than hedging of particular exposures. See “—Corporate and Other.”
Due to cash flow timing differences between our hedging instruments and the corresponding hedge target, as well as other factors such
as updates to actuarial assumptions which are not hedged, the market value of the hedge portfolio compared to our hedge target measured
as of any specific point in time may be different and is not expected to be fully offsetting. In addition to the derivatives held as part of the
hedging program, we have cash and other invested assets available to cover the future claims payable under these guarantees and other
liabilities. For additional information on the liquidity needs associated with our hedging program, see “—Liquidity and Capital
Resources—Liquidity—Liquidity associated with other activities—Hedging activities associated with living benefit guarantees.”
The primary sources of differences between the changes in the fair value of the hedge positions and the hedge target, other than
changes related to actuarial assumption updates, fall into one of three categories:
• Fund Performance—In order to project future account value changes, we make certain assumptions about how each underlying fund
will perform. We map contractholder funds to hedgeable indices that we believe are the best representation of the liability to be
hedged in the capital markets. The difference between the modeled fund performance and actual fund performance results in basis
that can be either positive or negative.
• Net Market Impact—We incur rebalancing costs related to the dynamic rebalancing of the hedging instruments as markets move.
Our hedging program is also subject to the impact of implied and realized market volatility on the hedge positions relative to our
hedge target that can lead to positive or negative results.
• Liability Basis—We make assumptions about expected changes in the hedge target related to certain items, such as contractholder
behavior. The difference between the actual change in the hedge target and the expected changes we have modeled results in basis
that can be either positive or negative.
The net impact of the change in the fair value of the embedded derivative associated with our living benefit features and the change in
the fair value of the related hedge positions is included in “Realized investment gains (losses), net, and related adjustments” and the related
impact to the amortization of DAC and other costs is included in “Related charges,” both of which are excluded from adjusted operating
income. The following table shows the net impact of changes in the embedded derivative and related hedge positions, as well as the related
amortization of DAC and other costs, for the periods indicated.
Year ended December 31,
2015 2014 2013
(1)
(in millions)
Hedge Program Results:
Change in value of hedge target(2)(3) ..................................................................... $(1,378) $(7,630) $ 9,234
Change in fair value of hedge positions .................................................................... 831 7,209 (9,465)
Net hedging impact(2)(4) ........................................................................... (547) (421) (231)
Reconciliation of Hedge Program Results to U.S. GAAP Results:
Net hedging impact (from above) ......................................................................... $ (547) $ (421) $ (231)
Change in portions of U.S. GAAP liability, before NPR, excluded from hedge target(2)(5) ........................... (67) (1,997) 902
Change in the NPR adjustment(2) ........................................................................ 2,243 3,824 (4,333)
Net impact from changes in the U.S. GAAP embedded derivative and hedge positions—reported in Individual
Annuities .................................................................................. 1,629 1,406 (3,662)
Related benefit (charge) to amortization of DAC and other costs(2) .............................................. (701) (496) 1,161
Net impact of annual assumption updates and other refinements ................................................. (34) (631) (1,533)
Net impact from changes in the U.S. GAAP embedded derivative and hedge positions, after the impact of NPR,
DAC and other costs—reported in Individual Annuities(4) ........................................... $ 894 $ 279 $(4,034)
(1) Positive amount represents income; negative amount represents a loss.
32 Prudential Financial, Inc. 2015 Annual Report