Derivative Instruments

9 Months Ended

Sep. 30, 2011

Notes to Financial Statements

Derivative Instruments

Derivative instruments

We use derivatives to manage certain risks in our general account portfolio as well as our insurance liabilities. Our derivatives do not qualify for hedge accounting treatment and are stated at fair value (market value) within other investments on our balance sheet, with changes in valuation reported in net realized investment gains/losses on our statements of income. The Company seeks to enter into over-the-counter (“OTC”) derivative transactions pursuant to master agreements that provide for a netting of payments and receipts by counterparty. As of September 30, 2011 and December 31, 2010, $7,510 thousand and $6,870 thousand, respectively, of cash and cash equivalents were held as collateral by a third party related to our derivative transactions.

Derivative Instruments Held in				Fair Value as of				Fair Value as of
General Account:				September  30, 2011				December  31, 2010
($ in thousands)	Notional
	Amount		Maturity	Asset		Liability		Asset		Liability
Non-hedging derivative instruments
Interest rate swaps	$	101,000	2017-2026	$	11,010	$	3,634	$	3,593	$	1,469
Variance swaps		935	2015-2017		3,174		--		--		577
Swaptions		25,000	2024		180		--		2,097		--
Put options		205,000	2016-2021		57,944		--		45,019		--
Call options		367,153	2011-2016		11,389		6,843		11,231		5,980
Equity futures		136,725	2011		24,039		--		28,501		--
Total non-hedging derivative instruments	$	835,813		$	107,736	$	10,477	$	90,441	$	8,026

Derivative Instrument Gains (Losses) Recognized in Earnings:(1)	Three Months Ended				Nine Months Ended
($ in thousands)	September  30,				September  30,
	2011		2010		2011		2010
Derivative instruments by type
Interest rate swaps	$	6,870	$	1,680	$	11,146	$	4,413
Variance swaps		5,404		--		3,751		--
Swaptions		(420)		737		(826)		1,907
Put options		23,010		(10,804)		18,010		21,582
Call options		(10,642)		(180)		(13,925)		(893)
Equity futures		16,380		(12,549)		10,575		(10,105)
Cross currency swaps		--		--		--		--
Total derivative instrument gains (losses) recognized in earnings	$	40,602	$	(21,116)	$	28,731	$	16,904

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⁽¹⁾ Excludes realized losses of $46,138 thousand and realized gains of $13,743 thousand on embedded derivatives for the three months ended September 30, 2011 and 2010 and realized losses of $41,630 thousand and $15,625 thousand on embedded derivatives for the nine months ended September 30, 2011 and 2010.

Interest Rate Swaps

We maintain an overall interest rate risk-management strategy that primarily incorporates the use of interest rate swaps as hedges of our exposure to changes in interest rates. Our exposure to changes in interest rates primarily results from our commitments to fund interest-sensitive insurance liabilities, as well as from our significant holdings of fixed rate financial instruments. We use interest rate swaps that effectively convert variable rate cash flows to fixed cash flows in order to hedge the interest rate risks associated with guaranteed minimum living benefit (GMAB/GMWB) rider liabilities.

Interest Rate Options

We use interest rate options, such as swaptions, to hedge against market risks to assets or liabilities from substantial changes in interest rates. An interest rate swaption gives us the right but not the obligation to enter into an underlying swap. Swaptions are options on interest rate swaps. All of our swaption contracts are receiver swaptions, which give us the right to enter into a swap where we will receive the agreed-upon fixed rate and pay the floating rate. If the market conditions are favorable and the swap is needed to continue hedging our inforce liability business, we will exercise the swaption and enter into a fixed rate swap. If a swaption contract is not exercised by its option maturity date, it expires with no value.

Exchange Traded Future Contracts

We use equity index futures to hedge the market risks from changes in the value of equity indices, such as S&P 500, associated with guaranteed minimum living benefit (GMAB/GMWB) rider liabilities. Positions are short-dated, exchange-traded futures with maturities of three months.

Equity Index Options

The Company uses equity indexed options to hedge against market risks from changes in equity markets, volatility and interest rates.

An equity index option affords the Company the right to make or receive payments based on a specified future level of an equity market index. The Company may use exchange-trade or OTC options.

Generally, the Company has used a combination of equity index futures, interest rate swaps, variance swaps and long-dated put options to hedge its GMAB and GMWB liabilities and equity index call options to hedge its indexed annuity option liabilities.

Contingent features

Derivative counterparty agreements may contain certain provisions that require our insurance companies’ financial strength rating to be above a certain threshold. If our financial strength ratings were to fall below a specified rating threshold, certain derivative counterparties could request immediate payment or demand immediate and ongoing full collateralization on derivative instruments in net liability positions, or trigger a termination of existing derivatives and/or future derivative transactions.

In certain derivative counterparty agreements, our financial strength ratings remain below the specified threshold levels as a result of rating downgrades in early 2009. However, the Company held no derivative instruments as of September 30, 2011 in a net liability position payable to any counterparty (i.e., such derivative instruments have fair values in a net asset position payable to the Company if such holdings were liquidated).