Management's discussion and analysis
Exposures to Market Risk
Interest Rate Risk - Our exposure to market risk for changes in interest rates is concentrated in our investment portfolio, and to a lesser extent, our debt obligations. However, changes in investment values attributable to interest rate changes are mitigated by corresponding and partially-offsetting changes in the economic value of our insurance reserves and debt obligations. We monitor this exposure through periodic reviews of our asset and liability positions. Our estimates of cash flows, as well as the impact of interest rate fluctuations relating to our investment portfolio and insurance reserves, are modeled and reviewed quarterly.
The following table provides principal runoff estimates by year for our Dec. 31, 1998 inventory of interest-sensitive financial instrument assets. Also provided are the weighted-average interest rates associated with each year's runoff. Principal runoff projections for collateralized mortgage obligations were prepared using third-party prepayment analyses. Runoff estimates for mortgage passthroughs were prepared using average prepayment rates for the prior three months. Principal runoff estimates for callable bonds are either to maturity or to the next call date depending on whether the call was projected to be "in-the-money" assuming no change in interest rates. No projection of the impact of reinvesting the estimated cash flow runoff is included in the table, regardless of whether the runoff source is a short-term or long-term fixed income security.
We have assumed that our "available-for-sale" securities are similar enough to aggregate those securities for purposes of this disclosure.
(In millions)
December 31, 1998
Fixed Maturities and Short-term Investments
Principal Cash Flows
Weighted Average Interest Rate
1999
$
3,612
6.2%
2000
1,734
7.3
2001
2,235
7.4
2002
2,010
7.3
2003
1,803
7.9
Thereafter
10,008
6.9
Total
$
21,402
$
22,039
Market value at Dec. 31, 1998
The estimated principal runoff on our mortgage loan investments is as follows: 1999, $42 million; 2000, $128 million; 2001, $58 million; 2002, $125 million; 2003, $117 million; thereafter, $164 million. The weighted average interest rate on those investments was 7.65% at Dec. 31, 1998. The estimated fair value of our mortgage loan investments at Dec. 31, 1998 was $629 million.
The following table provides principal runoff estimates by year for our Dec. 31, 1998 inventory of interest-sensitive debt obligations and related weighted average interest rates by stated maturity dates.
(In millions)
December 31, 1998
Medium-term Notes, Zero Coupon Notes
and Senior Notes
1999
$
20
7.6%
2000
-
-
2001
196
8.1
2002
49
7.5
2003
67
6.5
Thereafter
710
5.2
Total
$
1.042
$
1,039
Fair value at Dec. 31, 1998
Foreign Currency Exposure - Our exposure to market risk for changes in foreign exchange rates is concentrated in our invested assets denominated in foreign currencies, which are predominantly British pounds sterling. Cash flows from our foreign operations are the primary source of funds for our purchase of these investments. We purchase these investments primarily to hedge insurance reserves and other liabilities denominated in the same currency, effectively reducing our foreign currency exchange rate exposure.
The following table presents the U.S. dollar equivalent runoff estimates for our Dec. 31, 1998, inventory of sterling-denominated fixed-maturity and short-term investments. Also provided are the weighted-average interest rates associated with each year's runoff. Principal runoff estimates for callable bonds, if any, are either to maturity or to the next call date depending on whether the call was projected to be "in-the-money" assuming no change in interest rates. No projection of the impact of reinvesting the estimated cash flow runoff is included in the table, regardless of whether the runoff source is a short-term or long-term fixed income security.
Additionally, the table presents the quoted forward foreign currency exchange rates on forward contracts available as of Dec. 31, 1998.
(In millions)
December 31, 1998
Fixed Maturities and Short-term Investments
Principal Cash Flows
Weighted Average Interest Rate
Forward Foreign Currency Exchange Rate
British pounds sterling:
1999
$
91
6.5%
1.653
2000
58
8.9%
1.656
2001
75
8.5%
1.651
2002
132
7.0%
1,653
2003
14
7.2%
1,654
Thereafter
339
7.7%
Various
Total
$
709
$
764
Market value at Dec. 31, 1997
Equity Price Risk - Our portfolio of marketable equity securities, which we carry on our balance sheet at estimated fair value, has exposure to price risk. This risk is defined as the potential loss in estimated fair value resulting from an adverse change in prices. Our objective is to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities. Portfolio characteristics are analyzed regularly and market risk is actively managed through a variety of modeling techniques. Our holdings are diversified across industries, and concentrations in any one company or industry are limited by parameters established by senior management.
Our portfolio of venture capital investments also has exposure to market risks, primarily relating to the viability of the various entities in which we have invested. These investments by their nature involve more risk than other investments, and we actively manage our market risk in a variety of ways. First, we allocate a comparatively small amount of funds to venture capital. At the end of 1998, the cost of these investments accounted for only 2% of total invested assets. Second, the investments are diversified to avoid concentration of risk in a particular industry. Third, we perform extensive research prior to investing in a new venture to gauge prospects for success. Fourth, we regularly monitor the operational results of the entities in which we have invested. Finally, we generally sell our holdings in these firms soon after they become publicly traded, thereby reducing exposure to further market risk.
At Dec. 31, 1998, our marketable equity securities and venture capital investments were recorded at their estimated fair value of $1.83 billion. A hypothetical 10% decline in each stock's price would have resulted in a $183 million impact on fair value.