Prudential 2003 Annual Report Download - page 93

The tables above do not include approximately $104 billion of insurance reserve and deposit liabilities as of
December 31, 2003 and $99 billion as of December 31, 2002. We believe that the interest rate sensitivities of these
insurance liabilities offset, in large measure, the interest rate risk of the financial assets set forth in these tables.
The $598 million increase in the total estimated potential loss as of December 31, 2003 from December 31, 2002
resulted primarily from the increase in our portfolio of fixed maturities available for sale during 2003.
The estimated changes in fair values of our financial assets shown above relate primarily to assets invested to
support our insurance liabilities, but do not include assets associated with products for which investment risk is borne
primarily by the contract holders rather than by us.
Market Risk Related to Equity Prices
We actively manage equity price risk against benchmarks in respective markets. We benchmark our return on
equity holdings against a blend of market indices, mainly the S&P 500 and Russell 2000, and we target price
sensitivities that approximate those of the benchmark indices. We estimate our equity price risk from a hypothetical
10% decline in equity benchmark market levels and measure this risk in terms of the decline in fair market value of
equity securities we hold. Using this methodology, our estimated equity price risk as of December 31, 2003 was $340
million, representing a hypothetical decline in fair market value of equity securities we held at that date from $3.401
billion to $3.061 billion. Our estimated equity price risk using this methodology as of December 31, 2002 was $281
million, representing a hypothetical decline in fair market value of equity securities we held at that date from $2.807
billion to $2.526 billion. In calculating these amounts, we exclude equity securities related to products for which the
investment risk is borne primarily by the contractholder rather than by us. While these scenarios are for illustrative
purposes only and do not reflect our expectations regarding future performance of equity markets or of our equity
portfolio, they represent near term reasonably possible hypothetical changes that illustrate the potential impact of such
events.
Market Risk Related to Foreign Currency Exchange Rates
We are exposed to foreign currency exchange rate risk in our general account and through our operations in
foreign countries. In our international life insurance business, we generally invest in assets denominated in the same
currencies as our insurance liabilities, which mitigates our foreign currency exchange rate risk for these operations.
Our exposure to foreign currency risk within the general account investment portfolios supporting our U.S.
insurance operations arises primarily from purchased investments that are denominated or payable in foreign
currencies. We generally hedge substantially all foreign currency-denominated fixed-income investments supporting
our U.S. operations into U.S. dollars, using foreign exchange forward contracts and currency swaps, in order to
mitigate the risk that the fair value of these investments fluctuates as a result of changes in foreign exchange rates. We
generally do not hedge all of the foreign currency risk of our equity investments in unaffiliated foreign entities.
Our operations in foreign countries create two additional sources of foreign currency risk. First, we reflect the
operating results of our foreign branches and subsidiaries in our financial statements based on the average exchange
rates prevailing during the period. We hedge some of these foreign currency flows based on our overall risk
management strategy and loss limits. We generally hedge our anticipated exposure to adjusted operating income
fluctuations resulting from changes in foreign currency exchange rates relating to our International operations in Japan
and Korea, of which our Japanese insurance operations are the most significant, using foreign exchange forward
contracts and currency swaps. Second, we translate our equity investment in foreign branches and subsidiaries into
U.S. dollars using the foreign currency exchange rate at the financial statement period-end date. We have chosen to
partially hedge this exposure.
We actively manage foreign currency exchange rate risk within specified limits at the consolidated level using
VaR analysis. This statistical technique estimates, at a specified confidence level, the potential pre-tax loss in portfolio
market value that could occur over an assumed time horizon due to adverse market movements. We calculate this using
a variance/covariance approach.
Prudential Financial 2003 Annual Report 91