Derivatives

6 Months Ended

Jun. 30, 2022

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVES

DERIVATIVES

Fixed-index products provide traditional fixed annuities and universal life contracts with the option to have credited interest rates linked in part to an underlying equity index or a combination of equity indices. The equity return component of such policy contracts is identified separately and accounted for in future policy benefits as embedded derivatives on the Condensed Consolidated Balance Sheets. The remaining portions of these policy contracts are considered the host contracts and are recorded separately as fixed annuity or universal life contracts. The host contracts are accounted for under debt instrument type accounting in which future policy benefits are recorded as discounted debt instruments and accreted, using the effective yield method, to their minimum account values at their projected maturities or termination dates.

The Company purchases over-the-counter index options, which are derivative financial instruments, to hedge the equity return component of its fixed-index annuity and life products. The index options act as hedges to match closely the returns on the underlying index or indices. The amounts which may be credited to policyholders are linked, in part, to the returns of the underlying index or indices. As a result, changes to policyholders' liabilities are substantially offset by changes in the value of the options. Cash is exchanged upon purchase of the index options and no principal or interest payments are made by either party during the option periods. Upon maturity or expiration of the options, cash may be paid to the Company depending on the performance of the underlying index or indices and terms of the contract.

The Company does not elect hedge accounting relative to these derivative instruments. The index options are reported at fair value in the accompanying Condensed Consolidated Financial Statements. The changes in the values of the index options and the changes in the policyholder liabilities are both reflected in the Condensed Consolidated Statements of Earnings. Any changes relative to the embedded derivatives associated with policy contracts are reflected in contract interest in the Condensed Consolidated Statements of Earnings. Any gains or losses from the sale or expiration of the options, as well as period-to-period changes in values, are reflected as net investment income in the Condensed Consolidated Statements of Earnings.

Although there is credit risk in the event of nonperformance by counterparties to the index options, the Company does not expect any of its counterparties to fail to meet their obligations, given their high credit ratings. In addition, credit support agreements are in place with all counterparties for option holdings in excess of specific limits, which may further reduce the Company's credit exposure.

Effective December 31, 2020, the Company entered into a coinsurance funds withheld reinsurance agreement under which identified assets are maintained in a funds withheld account. While the assets are withheld, the associated interest and credit risk of these assets are transferred to the reinsurer, creating an embedded derivative on reinsurance in the funds withheld liability. Accordingly, the Company is required to bifurcate the embedded derivative from the host contract in accordance with GAAP. The fair value of the embedded derivative on reinsurance is computed as the unrealized gain (loss) on the underlying funds withheld assets. This amount is included as a component of the funds withheld liability balance on the Condensed Consolidated Balance Sheets with changes in the embedded derivative on reinsurance reported in Net investment income in the Condensed Consolidated Statements of Earnings. Changes in the funds withheld liability are reported in operating activities in the Condensed Consolidated Statements of Cash Flows.

The tables below present the fair value of derivative instruments as of June 30, 2022 and December 31, 2021, respectively.

	June 30, 2022
	Asset Derivatives			Liability Derivatives
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
		(In thousands)			(In thousands)
Derivatives not designated as hedging instruments
Equity index options	Derivatives, Index Options	$	6,071
Fixed-index products				Universal life and annuity contracts	$	45,342
Embedded derivative on reinsurance contract				Funds withheld liability	(270,614)
Total		$	6,071		$	(225,272)

	December 31, 2021
	Asset Derivatives			Liability Derivatives
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
		(In thousands)			(In thousands)
Derivatives not designated as hedging instruments
Equity index options	Derivatives, Index Options	$	101,622
Fixed-index products				Universal life and annuity contracts	$	142,761
Embedded derivative on reinsurance contract				Funds withheld liability	(84,725)
Total		$	101,622		$	58,036

The table below presents the effect of derivative instruments in the Condensed Consolidated Statements of Earnings for the three months ended June 30, 2022 and 2021.

		June 30, 2022		June 30, 2021
Derivatives Not Designated  As Hedging Instruments	Location of Gain  or (Loss) Recognized In Income on Derivatives	Amount of Gain or  (Loss) Recognized in  Income on Derivatives
		(In thousands)
Equity index options	Net investment income	$	(38,425)	40,166
Fixed-index products	Universal life and annuity contract interest	39,187		(48,819)
Embedded derivative on reinsurance contract	Net investment income	94,984		1,970
		$	95,746	(6,683)

The table below presents the effect of derivative instruments in the Condensed Consolidated Statements of Earnings for the six months ended June 30, 2022 and 2021.

		June 30, 2022		June 30, 2021
Derivatives Not Designated  As Hedging Instruments	Location of Gain  or (Loss) Recognized In Income on Derivatives	Amount of Gain or  (Loss) Recognized in  Income on Derivatives
		(In thousands)
Equity index options	Net investment income	$	(76,623)	68,190
Fixed-index products	Universal life and annuity contract interest	78,491		(80,085)
Embedded derivative on reinsurance contract	Net investment income	185,889		72,340
		$	187,757	60,445

The embedded derivative liability on fixed-index products, the change of which is recorded in universal life and annuity contract interest in the Condensed Consolidated Statements of Earnings, includes projected interest credits that are offset by the expected collectability by the Company of asset management fees on fixed-index products. The anticipated asset management fees to be collected increases or decreases based upon the most recent performance of index options and adds to or reduces the offset applied to the embedded derivative liability (increasing or decreasing contract interest expense). For the three months ended June 30, 2022 and 2021, the change in the embedded derivative liability due to the expected collectability of asset management fees increased contract interest expense by $0.0 million and $2.1 million, respectively. For the six months ended June 30, 2022 and 2021, the change in the embedded derivative liability due to the expected collectability of asset management fees increased/(decreased) contract interest expense by $0.0 million and $6.5 million, respectively.

Beginning in the second quarter of 2020, the Company changed its budget for purchasing these options to match the collection of asset management fees with the payoff from out-of-the-money options, thereby removing the option premium that was previously being paid for the probability or expectation of collecting asset management fees ("out-of-the-money" hedging). Consequently, for annuity products having asset management fee features the remaining one year options purchased under the prior method expired and were replaced by out-of-the-money hedges as of June 30, 2021. Accordingly, the embedded derivative liability component due to the projected collectability of asset management fees no longer exists in 2022.