6. Derivative Instruments

6 Months Ended

Jun. 30, 2012

Notes to Financial Statements

Derivative Instruments

6. Derivative Instruments

Derivative instruments

We use derivative financial instruments, including options, futures and swaps as a means of hedging exposure to interest rate, equity price change, equity volatility and foreign currency risk. This includes our surplus hedge which utilizes futures and options to hedge against declines in equity markets and the resulting statutory capital and surplus impact. We also use derivative instruments to economically hedge our exposure on living benefits offered on certain of our variable products as well as index credits on our fixed indexed annuity products.

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 June 30, 2012 and December 31, 2011, $7,885 thousand and $7,510 thousand, respectively, of cash and cash equivalents were held as collateral by a third party related to our derivative transactions.

Our derivatives generally do not qualify for hedge accounting. We do not designate the purchased derivatives related to variable annuity living benefits or fixed indexed annuity index credits as hedges for accounting purposes.

Derivative Instruments:		Fair Value as of June 30, 2012						Fair Value as of December 31, 2011
($ in thousands)		Notional						Notional
	Maturity	Amount		Assets		Liabilities		Amount		Assets		Liabilities
Non-hedging derivative instruments
Interest rate swaps	2017-2026	$	116,000	$	12,466	$	4,654	$	101,000	$	10,792	$	3,472
Variance swaps	2015-2017		935		--		1,310		935		3,202		--
Swaptions	2024		25,000		60		--		25,000		254		--
Put options	2015-2021		200,000		50,950		--		200,000		54,833		--
Call options	2012-2017		635,481		50,754		33,515		354,933		27,956		18,985
Equity futures	2012		200,529		15,418		--		66,347		16,185		--
Total non-hedging   derivative instruments		$	1,177,945	$	129,648	$	39,479	$	748,215	$	113,222	$	22,457

Derivative Instrument Realized Gains (Losses) Recognized in Earnings:	Three Months Ended				Six Months Ended
($ in thousands)	June 30,				June 30,
	2012		2011		2012		2011
Derivative instruments by type
Interest rate swaps	$	1,783	$	4,822	$	492	$	4,276
Variance swaps		876		(278)		(4,512)		(1,653)
Swaptions		(40)		(217)		(194)		(406)
Put options		7,851		2,275		(3,883)		(5,000)
Call options		(9,843)		(5,006)		22		(3,283)
Equity futures		5,221		(126)		(9,605)		(5,805)
Total derivative instrument realized gains (losses) recognized in earnings	$	5,848	$	1,470	$	(17,680)	$	(11,871)

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

We use equity indexed options to hedge against market risks from changes in equity markets, volatility and interest rates.

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

Generally, we have 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 are below the specified threshold levels. However, the Company held no derivative instruments as of June 30, 2012 in a net aggregate 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).