Prudential 2003 Annual Report Download - page 91

and Results of Operations—Result of Operations for Financial Services Businesses by Segment—Insurance Division—
Individual Life and Annuities” for payments made under the guaranteed minimum death benefit provision of certain
individual annuity contracts, which we do not believe add significantly to our overall market risk.
We manage our exposure to equity price risk relating to our general account primarily by seeking to match the risk
profile of equity investments against risk-adjusted equity market benchmarks. We measure benchmark risk levels in
terms of price volatility in relation to the market in general.
The sources of our exposure to market risk can be divided into two categories, “other than trading” activities
conducted primarily in our insurance, annuity and guaranteed products operations, and “trading” activities conducted
primarily in our equity and futures operations, as well as, historically, in our former domestic retail securities brokerage
business. As part of our management of both “other than trading” and “trading” market risks, we use a variety of risk
management tools and techniques. These include sensitivity and Value-at-Risk (“VaR”) measures, position and other
limits based on type of risk, and various hedging methods.
Other Than Trading Activities
We hold the majority of our assets for “other than trading” activities in our segments that offer insurance,
annuities and guaranteed products. We incorporate asset/liability management techniques and other risk management
policies and limits into the process of investing our assets. We use derivatives for hedging purposes in the asset/
liability management process.
Insurance, Annuities and Guaranteed Products Asset/Liability Management
We seek to maintain interest rate and equity exposures within established ranges, which we periodically adjust
based on market conditions and the design of related products sold to customers. Our risk managers establish
investment risk limits for exposures to any issuer, geographic region, type of security or industry sector and oversee
efforts to manage risk within policy constraints set by management and approved by the Board of Directors.
We use duration and convexity analyses to measure price sensitivity to interest rate changes. Duration measures
the relative sensitivity of the fair value of a financial instrument to changes in interest rates. Convexity measures the
rate of change of duration with respect to changes in interest rates. We seek to manage our interest rate exposure by
legal entity by matching the relative sensitivity of asset and liability values to interest rate changes, or controlling
“duration mismatch” of assets and liabilities. We have target duration mismatch constraints for each entity. As of
December 31, 2003 and 2002, the difference between the pre-tax duration of assets and the target duration of liabilities
in our duration managed portfolios was within our constraint limits. We consider risk-based capital implications in our
asset/liability management strategies.
We also perform portfolio stress testing as part of our regulatory cash flow testing. In this testing, we evaluate the
impact of altering our interest-sensitive assumptions under various moderately adverse interest rate environments.
These interest-sensitive assumptions relate to the timing and amount of redemptions and prepayments of fixed-income
securities and lapses and surrenders of insurance products and the potential impact of any guaranteed minimum interest
rates. We evaluate any shortfalls that this cash flow testing reveals to determine if we need to increase statutory
reserves or adjust portfolio management strategies.
Market Risk Related to Interest Rates
Our “other than trading” assets that subject us to interest rate risk include primarily fixed maturity securities,
commercial loans and policy loans. In the aggregate, the carrying value of these assets represented 74% of our
consolidated assets, other than assets that we held in separate accounts, as of December 31, 2003 and 70% as of
December 31, 2002.
With respect to “other than trading” liabilities, we are exposed to interest rate risk through policyholder account
balances relating to interest-sensitive life insurance, annuity and investment-type contracts and through outstanding
short-term and long-term debt.
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