Ameriprise 2006 Annual Report Download - page 52

and remain at that level for 12 months, we estimate that the
fair value would decrease by $57 million with a favorable
impact to pretax income. The GMWB interest rate exposure is
hedged with a portfolio of customized equity index puts and
interest rate swaps. At December 31, 2006, we had equity puts
with a notional amount of $1.4 billion, and interest rate swaps
with a notional amount of $359 million. Terms of the swaps
designate us as the variable rate payor. If interest rates were to
increase we would have to pay more to the swap counterparty,
and the fair value of our equity puts would decrease, resulting
in a negative impact to our pretax income. For a hypothetical
100 basis point increase in interest rates sustained for a
12 month period, we estimate that the negative impact of the
derivatives on pretax income would be $53 million. The net
impact on pretax income after hedging would be a favorable
$4 million.
Our GMAB creates interest rate risk in the same way as the
GMWB discussed above—the fair value of the guaranteed
benefits changes with changes in interest rates. For a
hypothetical 100 basis point increase in interest rates at
December 31, 2006 sustained for 12 months, the fair value of
the GMAB would decrease by $8 million, with a corresponding
favorable impact on our pretax income. We do not hedge the
interest rate exposure on the GMAB.
Separate account assets are held for the exclusive benefit of
variable annuity and VUL contractholders. We do, however,
receive asset-based investment management fees on fixed
income investments our annuity and VUL policyholders have in
the separate accounts. An increase in interest rates would
decrease fixed rate separate account assets and decrease
related fees with a negative impact to pretax income. This
exposure is included in “Interest Rate Risk—Asset-Based
Management and 12b-1 Fees” earlier in this section.
Equity Price Risk—Variable Annuities and VUL Products
The variable annuity guaranteed benefits guarantee payouts to
the annuity holder under certain specific conditions regardless
of the performance of the investment assets. For this reason,
when equity markets decline, the returns from the separate
account assets coupled with guaranteed benefit fees from
annuity holders may not be sufficient to fund expected pay-
outs. In that case, reserves must be increased with a negative
impact to earnings. We estimate the negative impact on pretax
income before hedging to be $42 million if, hypothetically,
equity markets had declined by 10% at December 31, 2006
and remain at that level for 12 months. Of the $42 million,
$7 million is attributable to our GMWB.
Currently, we only hedge our GMWB. Our hedging program is
static which reduces our risk to major disruptions in the
market and severe liquidity events because our program does
not rely on frequent dynamic rebalancing and the ability to
trade in the market. In addition, the primarily static nature of
the hedge reduces the likelihood of operational and execution
errors. The core derivative instrument with which we hedge the
equity price risk of our GMWB is a long-dated structured equity
put contract; this core instrument is supplemented with equity
futures. The equity put contracts had a notional amount of
$1.4 billion at December 31, 2006. If, hypothetically, equity
markets had declined by 10% at December 31, 2006 and
remain at that level for 12 months we estimate a positive
impact to pretax income of $4 million from the puts and
futures. The net equity price exposure to pretax income from
all of our variable annuity guaranteed benefits would be a
negative $38 million.
A decline in equity markets would also reduce the asset-based
management fees we earn on equity market investments that
our annuity and VUL policyholders have in separate accounts.
This exposure is included in “Equity Price Risk—Asset-Based
Management and 12b-1 Fees” earlier in this section.
Fixed Annuities, Fixed Portion of Variable
Annuities, Fixed Portion of VUL and Fixed
Insurance Products
Interest rate exposures arise primarily with respect to the fixed
account portion of RiverSource Life’s annuity and insurance
products and its investment portfolio. We guarantee an interest
rate to the holders of these products. Premiums collected from
clients are primarily invested in fixed rate securities to fund the
client credited rate with the spread between the rate earned
from investments and the rate credited to clients recorded as
earned income. Client liabilities and investment assets
generally differ as it relates to basis, repricing or maturity
characteristics. Rates credited to clients’ accounts generally
reset at shorter intervals than the yield on the underlying
investments. Therefore, in an increasing rate environment,
higher interest rates are reflected in crediting rates to clients
sooner than in rates earned on invested assets resulting in a
reduced spread between the two rates, reduced earned income
and a negative impact on pretax income. We have $26.5 billion
in reserves in future policy benefits and claims on our
Consolidated Balance Sheets at December 31, 2006 to
recognize liabilities created by these products. To hedge
against the risk of higher interest rates we have purchased
swaption contracts which had the following notional amounts
and fair value assets:
50 Ameriprise Financial, Inc. 2006 Annual Report
December 31,
2006 2005
Notional Fair Notional Fair
Amount Value Amount Value
(in millions)
Purchased swaptions $ 1,200 $ 2 $ 1,200 $ 8