Prudential 2007 Annual Report Download - page 96

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 bank-loan inventory(1) ........................................ 918 900 (18)
Policy loans ......................................................... 9,837 9,205 (632)
Derivatives:
Swaps .......................................................... $41,582 (342) (561) (219)
Futures ......................................................... 3,392 1 20 19
Options ........................................................ 3,131 250 218 (32)
Forwards ....................................................... 9,646 122 19 (103)
Variable Annuity Living Benefit Feature Embedded Derivatives ........... 38 119 81
Financial liabilities with interest rate risk:
Short-term and long-term debt ...................................... (24,276) (23,450) 826
Investment contracts .............................................. (64,571) (63,310) 1,261
Bank customer liabilities ........................................... (903) (903) —
Net estimated potential loss ................................................. $(10,109)
(1) The hypothetical change in fair value related to our mortgage bank-loan inventory reflects only the gross fair value change on the mortgage loan assets,
and excludes any offsetting impact of derivatives and other instruments purchased to hedge such changes in fair value.
The tables above do not include approximately $129 billion of insurance reserve and deposit liabilities as of December 31, 2007 and
$123 billion as of December 31, 2006. 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 in fair value as of December 31, 2007 increased $293 million from December 31, 2006, primarily
reflecting an increase in the level of investments in 2007.
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 separate account assets associated with products for which investment risk is borne primarily by the separate
account 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 investment 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
investment equity price risk as of December 31, 2007 was $958 million, representing a hypothetical decline in fair market value of equity
securities we held at that date from $9.580 billion to $8.622 billion. Our estimated investment equity price risk using this methodology 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. In calculating these amounts, we exclude separate account equity securities related to products for
which the investment risk is borne primarily by the separate account contractholder rather than by us.
In addition to equity securities, as indicated above, we hold equity-based derivatives primarily to hedge the equity price risk embedded
in the living benefit features in some of our variable annuity products. As of December 31, 2007, our equity-based derivatives had notional
values of $4.6 billion, and were reported at fair value as a $617 million asset, and the living benefit features accounted for as derivatives
were reported at fair value as a $168 million liability. As of December 31, 2006, our equity-based derivatives had notional values of $2.9
billion, and were reported at fair value as a $230 million asset, and the living benefits features accounted for as derivatives were reported at
fair value as a $38 million asset. Our estimated equity price risk associated with the equity-based derivatives, net of the related living
benefit features, was less than $10 million as of both December 31, 2007 and 2006, estimated based on a hypothetical 10% decline in
equity benchmark market levels.
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. These scenarios consider only the direct impact on fair value of declines in equity benchmark market levels and not changes in
asset based fees recognized as revenue, changes in our estimates of total gross profits used as a basis for amortizing deferred policy
acquisition and other costs, or changes in any other assumptions such as mortality, utilization or persistency rates in our variable annuity
contracts that could also impact the fair value of our living benefit features.
94 Prudential Financial 2007 Annual Report