Prudential 2005 Annual Report Download - page 76
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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, 2005 and 2004, 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 78% of our consolidated assets, other than assets that we held
in separate accounts, as of December 31, 2005 and 70% as of December 31, 2004.
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 other investment-type contracts, collectively referred to as investment contracts, and through
outstanding short-term and long-term debt.
Prudential Financial 2005 Annual Report74