Prudential 2006 Annual Report Download - page 87

constraints for each entity. As of December 31, 2006 and 2005, 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 U.S. regulatory cash flow testing for major product lines that are subject to risk
from changes in interest rates. 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 77% of our consolidated assets, other than assets that we held
in separate accounts, as of December 31, 2006 and 78% as of December 31, 2005.
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.
We assess interest rate sensitivity for “other than trading” financial assets, financial liabilities and derivatives using hypothetical test
scenarios that assume either upward or downward 100 basis point parallel shifts in the yield curve from prevailing interest rates. The
following tables set forth the net estimated potential loss in fair value from a hypothetical 100 basis point upward shift as of December 31,
2006 and 2005, because this scenario results in the greatest net exposure to interest rate risk of the hypothetical scenarios tested at those
dates. While the test scenario is for illustrative purposes only and does not reflect our expectations regarding future interest rates or the
performance of fixed-income markets, it is a near-term, reasonably possible hypothetical change that illustrates the potential impact of such
events. These test scenarios do not measure the changes in value that could result from non-parallel shifts in the yield curve, which we
would expect to produce different changes in discount rates for different maturities. As a result, the actual loss in fair value from a 100
basis point change in interest rates could be different from that indicated by these calculations.
As of December 31, 2006
Notional
Amount of
Derivatives
Fair
Value
Hypothetical Fair
Value After + 100
Basis Point Parallel
Yield Curve Shift
Hypothetical
Change in
Fair Value
(in millions)
Financial assets with interest rate risk:
Fixed maturities ...................................................... $179,163 $168,952 $(10,211)
Commercial loans .................................................... 25,225 24,144 (1,081)
Mortgage broker-loan inventory ......................................... 918 916 (2)
Policy loans ......................................................... 9,837 9,205 (632)
Derivatives:
Swaps .......................................................... $41,582 (342) (595) (253)
Futures ......................................................... 3,392 1 20 19
Options ........................................................ 358 18 8 (10)
Forwards ....................................................... 9,646 122 19 (103)
Financial liabilities with interest rate risk:
Short-term and long-term debt ...................................... (24,276) (23,450) 826
Investment contracts .............................................. (68,372) (67,112) 1,260
Bank customer liabilities ........................................... (903) (903) —
Net estimated potential loss ................................................. $(10,187)
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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