Derivative Instruments

We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. None of our derivatives qualify for hedge accounting, thus, any change in the fair value of the derivatives is recognized immediately in the consolidated statements of operations. The fair value of our derivative instruments, including derivative instruments embedded in fixed index annuity contracts and derivative instruments embedded in a convertible debt issue, presented in the consolidated balance sheets are as follows:



	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Assets
Derivative instruments
Call options	$	790,396	$	856,050
Other assets
2015 notes hedges	86,640		107,041
Interest rate caps	4,926		6,103
Interest rate swap	—		712
	$	881,962	$	969,906
Liabilities
Policy benefit reserves - annuity products
Fixed index annuities - embedded derivatives	$	4,755,913	$	4,406,163
Other liabilities
2015 notes embedded conversion derivative	86,640		107,041
Interest rate swap	690		—
	$	4,843,243	$	4,513,204

The changes in fair value of derivatives included in the unaudited consolidated statements of operations are as follows:



	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Change in fair value of derivatives:
Call options	$	71,473		$	344,654
2015 notes hedges	(20,401		)	28,098
Interest rate swap	(1,402		)	733
Interest rate caps	(1,177		)	477
	$	48,493		$	373,962
Change in fair value of embedded derivatives:
2015 notes embedded conversion derivative	$	(20,401	)	$	28,098
Fixed index annuities—embedded derivatives	113,020			335,174
	$	92,619		$	363,272

We have fixed index annuity products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the gain in a specified market index. When fixed index annuity deposits are received, a portion of the deposit is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to fixed index annuity policyholders. Substantially all such call options are one year options purchased to match the funding requirements of the underlying policies. The call options are marked to fair value with the change in fair value included as a component of revenues. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and we purchase new one-year call options to fund the next annual index credit. We manage the cost of these purchases through the terms of our fixed index annuities, which permit us to change caps, participation rates, and/or asset fees, subject to guaranteed minimums on each policy's anniversary date. By adjusting caps, participation rates, or asset fees, we can generally manage option costs except in cases where the contractual features would prevent further modifications.

Our strategy attempts to mitigate any potential risk of loss under these agreements through a regular monitoring process which evaluates the program's effectiveness. We do not purchase call options that would require payment or collateral to another institution and our call options do not contain counterparty credit-risk-related contingent features. We are exposed to risk of loss in the event of nonperformance by the counterparties and, accordingly, we purchase our option contracts from multiple counterparties and evaluate the creditworthiness of all counterparties prior to purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a Standard and Poor's credit rating of A- or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration limits. We also have credit support agreements that allow us to request the counterparty to provide collateral to us when the fair value of our exposure to the counterparty exceeds specified amounts.

The notional amount and fair value of our call options by counterparty and each counterparty's current credit rating are as follows:



			March 31, 2014				December 31, 2013
Counterparty	Credit Rating (S&P)	Credit Rating (Moody's)	Notional Amount		Fair Value		Notional Amount		Fair Value
			(Dollars in thousands)
Bank of America	A	A2	$	1,590,121	$	61,063	$	1,683,911	$	73,836
Barclays	A	A2	1,927,994		61,753		2,396,839		113,513
BNP Paribas	A+	A2	1,299,886		36,924		1,382,661		38,849
Citibank, N.A.	A	A2	2,423,596		81,072		1,536,547		72,310
Credit Suisse	A	A1	4,101,721		193,008		4,060,352		193,304
Deutsche Bank	A	A2	838,142		35,175		747,587		41,074
HSBC	AA-	A1	169,761		6,442		200,011		10,518
J.P. Morgan	A+	Aa3	923,585		39,197		786,429		36,863
Morgan Stanley	A-	Baa2	3,847,956		154,226		3,546,487		150,437
Royal Bank of Canada	AA-	Aa3	871,208		31,084		714,941		25,140
Wells Fargo	AA-	Aa3	2,287,890		90,452		2,221,874		100,206
			$	20,281,860	$	790,396	$	19,277,639	$	856,050

As of March 31, 2014 and December 31, 2013, we held $679.6 million and $818.2 million, respectively, of cash and cash equivalents and other securities from counterparties for derivative collateral, which is included in other liabilities on our consolidated balance sheets. This derivative collateral limits the maximum amount of economic loss due to credit risk that we would incur if parties to the call options failed completely to perform according to the terms of the contracts to $114.5 million and $71.7 million at March 31, 2014 and December 31, 2013, respectively.

The future annual index credits on our fixed index annuities are treated as a "series of embedded derivatives" over the expected life of the applicable contract. We do not purchase call options to fund the index liabilities which may arise after the next policy anniversary date. We must value both the call options and the related forward embedded options in the policies at fair value.

We entered into an interest rate swap and interest rate caps to manage interest rate risk associated with the floating rate component on certain of our subordinated debentures. See Note 10 in our Annual Report on Form 10-K for the year ended December 31, 2013 for more information on our subordinated debentures. The terms of the interest rate swap provide that we pay a fixed rate of interest and receive a floating rate of interest. The terms of the interest rate caps limit the three month London Interbank Offered Rate ("LIBOR") to 2.50%. The interest rate swap and caps are not effective hedges under accounting guidance for derivative instruments and hedging activities. Therefore, we record the interest rate swap and caps at fair value and any net cash payments received or paid are included in the change in fair value of derivatives in the unaudited consolidated statements of operations.

Details regarding the interest rate swap are as follows:

Notional

Pay

March 31, 2014

December 31, 2013

Maturity Date

Amount

Receive Rate

Rate

Counterparty

Fair Value

(Dollars in thousands)

March 15, 2021

85,500

LIBOR

2.415

SunTrust

(690

)

712

Details regarding the interest rate caps are as follows:



	Notional			Cap			March 31, 2014		December 31, 2013
Maturity Date	Amount		Floating Rate	Rate		Counterparty	Fair Value		Fair Value
							(Dollars in thousands)
July 7, 2021	$	40,000	LIBOR	2.50	%	SunTrust	$	2,481	$	3,073
July 8, 2021	12,000		LIBOR	2.50	%	SunTrust	745		923
July 29, 2021	27,000		LIBOR	2.50	%	SunTrust	1,700		2,107
	$	79,000					$	4,926	$	6,103

The interest rate swap converts floating rates to fixed rates for seven years beginning March 2014. The interest rate caps have a forward starting date beginning in July 2014 and cap our interest rates for seven years. As of March 31, 2014, we held $4.0 million of cash and cash equivalents from the counterparty for derivative collateral related to the swap and caps, which is included in other liabilities on our consolidated balance sheets.

In September 2010, concurrently with the issuance of $200.0 million principal amount of 3.5% Convertible Senior Notes due September 15, 2015 (the "2015 notes"), we entered into hedge transactions (the "2015 notes hedges") with two counterparties whereby we have the option to receive the cash equivalent of the conversion spread on 16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the 2015 notes. These options expire on September 15, 2015, and must be settled in cash. The 2015 notes hedges are accounted for as derivative assets and are included in other assets in our consolidated balance sheets. The 2015 notes embedded conversion derivative and the 2015 notes hedges are adjusted to fair value each reporting period and unrealized gains and losses are reflected in our unaudited consolidated statements of operations. At March 31, 2014, 2015 notes hedges are outstanding that were not settled with the partial unwind agreements whereby we have the option to receive the cash equivalent of the conversion spread on 7.5 million shares of our common stock based upon a strike price of $12.35 per share.

In separate transactions, we also sold warrants (the "2015 warrants") to two counterparties for the purchase of up to 16.0 million shares of our common stock at a price of $16.00 per share. We received $15.6 million in cash proceeds from the sale of the 2015 warrants, which was recorded as an increase in additional paid-in capital. The number of shares and strike price of the warrants are subject to adjustment based on dividends we pay subsequent to selling the warrants. The warrants expire on various dates from December 2015 through March 2016 and are intended to be settled in net shares. The total number of shares of common stock deliverable under the 2015 warrants is, however, currently limited to 11.7 million shares. Changes in the fair value of these warrants will not be recognized in our consolidated financial statements as long as the instruments remain classified as equity. At March 31, 2014, the remaining 2015 warrants that were not settled with the partial unwind agreements were dilutive as the average price of our common stock exceeded the $15.75 strike price of the 2015 warrants and the effect has been included in diluted earnings per share for the three months ended March 31, 2014. The warrants were not dilutive for the three months ended March 31, 2013.

Subsequent to March 31, 2014, we entered into three separate partial unwind agreements with the two counterparties to the 2015 notes hedges and the 2015 warrants to coincide with the extinguishment of a portion of our 2015 notes, see note 6, whereby we agreed to settle the related 2015 notes hedges and the 2015 warrants and received net cash from the counterparties totaling $7.2 million. Subsequent to the settlement of these unwind agreements and certain conversion rate adjustments due to dividends paid, 2015 notes hedges remain outstanding whereby we have the option to receive the cash equivalent of the conversion spread on 4.8 million shares of our common stock based upon a strike price of $12.35 per share and warrants remain outstanding for the purchase of up to 4.8 million shares of our common stock at a strike price of $15.75 per share.