Prudential 2006 Annual Report Download - page 88

As of December 31, 2005
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 ...................................................... $170,114 $159,957 $(10,157)
Commercial loans .................................................... 23,952 22,931 (1,021)
Mortgage broker-loan inventory ......................................... 1,143 1,139 (4)
Policy loans ......................................................... 9,440 8,832 (608)
Derivatives:
Swaps .......................................................... $29,330 (534) (598) (64)
Futures ......................................................... 2,219 1 65 64
Options ........................................................ 337 20 10 (10)
Forwards ....................................................... 9,103 (70) (128) (58)
Financial liabilities with interest rate risk:
Short-term and long-term debt ...................................... (19,845) (19,223) 622
Investment contracts .............................................. (64,529) (63,269) 1,260
Bank customer liabilities ........................................... (503) (503) —
Net estimated potential loss ................................................. $ (9,976)
The tables above do not include approximately $119 billion of insurance reserve and deposit liabilities as of December 31, 2006 and
$113 billion as of December 31, 2005. 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.
Our net estimated potential loss as of December 31, 2006 increased $211 million from December 31, 2005.
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 contractholders rather than
by us.
Market Risk Related to Equity Prices
We actively manage investment 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, 2006 was $916 million, representing a hypothetical decline in fair market value of equity securities we held
at that date from $9.160 billion to $8.244 billion. Our estimated equity price risk using this methodology as of December 31, 2005 was
$808 million, representing a hypothetical decline in fair market value of equity securities we held at that date from $8.084 billion to $7.276
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 domestic general account investment portfolios, other proprietary
investment portfolios and through our operations in foreign countries.
Our exposure to foreign currency risk within the domestic general account investment portfolios supporting our U.S. insurance
operations and other domestic proprietary investment portfolios arises primarily from investments that are denominated in foreign
currencies. We generally hedge substantially all domestic general account foreign currency-denominated fixed-income investments and
other domestic proprietary foreign currency investments into U.S. dollars in order to mitigate the risk that the cash flows or fair value of
these investments fluctuates as a result of changes in foreign currency exchange rates. We generally do not hedge all of the foreign
currency risk of our investments in equity securities of unaffiliated foreign entities.
Our operations in foreign countries create the following three additional sources of foreign currency risk:
• First, we reflect the operating results of our foreign operations in our financial statements based on the average exchange rates
prevailing during the period. We hedge some of these foreign currency operating results as part of our overall risk management
strategy. We generally hedge our anticipated exposure to adjusted operating income fluctuations resulting from changes in foreign
currency exchange rates relating to our International operations primarily in Japan, Korea, Taiwan and Europe.
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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