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DERIVATIVE FINANCIAL INSTRUMENTS
 3 Months Ended
Mar. 31, 2017
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS
DERIVATIVE FINANCIAL INSTRUMENTS
Types of Derivative Instruments and Derivative Strategies
The Company utilizes a risk management strategy that incorporates the use of derivative financial instruments to reduce exposure to certain risks, including but not limited to, interest rate risk, currency exchange risk, volatility risk, and equity market risk. These strategies are developed through the Company’s analysis of data from financial simulation models and other internal and industry sources and are then incorporated into the Company’s risk management program.
Derivative instruments expose the Company to credit and market risk and could result in material changes from period to period. The Company attempts to minimize its credit risk by entering into transactions with highly rated counterparties. The Company manages the market risk by establishing and monitoring limits as to the types and degrees of risk that may be undertaken. The Company monitors its use of derivatives in connection with its overall asset/liability management programs and risk management strategies. In addition, all derivative programs are monitored by our risk management department.
Derivatives Related to Interest Rate Risk Management
Derivative instruments that are used as part of the Company’s interest rate risk management strategy include interest rate swaps, interest rate futures, interest rate caps, and interest rate swaptions.
Derivatives Related to Foreign Currency Exchange Risk Management
Derivative instruments that are used as part of the Company's foreign currency exchange risk management strategy include foreign currency swaps, foreign currency futures, foreign equity futures, and foreign equity options.
Derivatives Related to Risk Mitigation of Certain Annuity Contracts
The Company may use the following types of derivative contracts to mitigate its exposure to certain guaranteed benefits related to VA contracts and fixed indexed annuities:
•Foreign Currency Futures
•Variance Swaps
•Interest Rate Futures
•Equity Options
•Equity Futures
•Credit Derivatives
•Interest Rate Swaps
•Interest Rate Swaptions
•Volatility Futures
•Volatility Options
•Funds Withheld Agreement
•Total Return Swaps
Other Derivatives
The Company and certain of its subsidiaries have derivatives with PLC. These derivatives consist of an interest support agreement, YRT premium support agreements, and portfolio maintenance agreements with PLC.
The Company has a funds withheld account that consists of various derivative instruments held by us that is used to hedge the GLWB and GMDB riders. The economic performance of derivatives in the funds withheld account is ceded to Shades Creek. The funds withheld account is accounted for as a derivative financial instrument.
Accounting for Derivative Instruments
The Company records its derivative financial instruments in the consolidated balance sheet in “other long-term investments” and “other liabilities” in accordance with GAAP, which requires that all derivative instruments be recognized in the balance sheet at fair value. The change in the fair value of derivative financial instruments is reported either in the statement of income or in other comprehensive income (loss), depending upon whether it qualified for and also has been properly identified as being part of a hedging relationship, and also on the type of hedging relationship that exists.
For a derivative financial instrument to be accounted for as an accounting hedge, it must be identified and documented as such on the date of designation. For cash flow hedges, the effective portion of their realized gain or loss is reported as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged item impacts earnings. Any remaining gain or loss, the ineffective portion, is recognized in current earnings. For fair value hedge derivatives, their gain or loss as well as the offsetting loss or gain attributable to the hedged risk of the hedged item is recognized in current earnings. Effectiveness of the Company’s hedge relationships is assessed on a quarterly basis.
The Company reports changes in fair values of derivatives that are not part of a qualifying hedge relationship through earnings in the period of change. Changes in the fair value of derivatives that are recognized in current earnings are reported in “Realized investment gains (losses)-Derivative financial instruments.”
Derivative Instruments Designated and Qualifying as Hedging Instruments
Cash-Flow Hedges
•
To hedge a fixed rate note denominated in a foreign currency, the Company entered into a fixed-to-fixed foreign currency swap in order to hedge the foreign currency exchange risk associated with the note. The cash flows received on the swap are identical to the cash flow paid on the note.
Derivative Instruments Not Designated and Not Qualifying as Hedging Instruments
The Company uses various other derivative instruments for risk management purposes that do not qualify for hedge accounting treatment. Changes in the fair value of these derivatives are recognized in earnings during the period of change.
Derivatives Related to Variable Annuity Contracts
•
The Company uses equity, interest rate, currency, and volatility futures to mitigate the risk related to certain guaranteed minimum benefits, including GLWB, within its VA products. In general, the cost of such benefits varies with the level of equity and interest rate markets, foreign currency levels, and overall volatility.
•
The Company uses equity options, variance swaps, and volatility options to mitigate the risk related to certain guaranteed minimum benefits, including GLWB, within its VA products. In general, the cost of such benefits varies with the level of equity markets and overall volatility.
•
The Company uses interest rate swaps and interest rate swaptions to mitigate the risk related to certain guaranteed minimum benefits, including GLWB, within its VA products.
•
The Company markets certain VA products with a GLWB rider. The GLWB component is considered an embedded derivative, not considered to be clearly and closely related to the host contract.
•
The Company has a funds withheld account that consists of various derivative instruments held by the Company that are used to hedge the GLWB and GMDB riders. The economic performance of derivatives in the funds withheld account is ceded to Shades Creek. The funds withheld account is accounted for as a derivative financial instrument.
Derivatives Related to Fixed Annuity Contracts
•
The Company uses equity futures and options to mitigate the risk within its fixed indexed annuity products. In general, the cost of such benefits varies with the level of equity markets and overall volatility.
•
The Company markets certain fixed indexed annuity products. The FIA component is considered an embedded derivative, not considered to be clearly and closely related to the host contract.
Derivatives Related to Indexed Universal Life Contracts
•
The Company uses equity, futures, and options to mitigate the risk within its indexed universal life products. In general, the cost of such benefits varies with the level of equity markets.
•
The Company markets certain IUL products. The IUL component is considered an embedded derivative, not considered to be clearly and closely related to the host contract.
Other Derivatives
•
The Company and certain of its subsidiaries have an interest support agreement, two YRT premium support agreements, and three portfolio maintenance agreements with PLC. The Company entered into three separate portfolio maintenance agreements, two in October 2012 and one in January 2016.
•
The Company uses various swaps and other types of derivatives to manage risk related to other exposures.
•
The Company is involved in various modified coinsurance and funds withheld arrangements which contain embedded derivatives. Changes in their fair value are recorded in current period earnings. The investment portfolios that support the related modified coinsurance reserves and funds withheld arrangements had fair value changes which substantially offset the gains or losses on these embedded derivatives.
The following table sets forth realized investments gains and losses for the periods shown:
Realized investment gains (losses) - derivative financial instruments
 
For The
Three Months Ended
March 31,
 
2017
 
2016
 
(Dollars In Thousands)
Derivatives related to VA contracts:
 

 
 
Interest rate futures - VA
$
3,448

 
$
37,801

Equity futures - VA
(30,817
)
 
(3,228
)
Currency futures - VA
(6,256
)
 
(6,158
)
Equity options - VA
(40,185
)
 
16,304

Interest rate swaptions - VA
(1,469
)
 
(2,234
)
Interest rate swaps - VA
(8,957
)
 
125,593

Embedded derivative - GLWB
10,016

 
(66,676
)
Funds withheld derivative
47,469

 
(7,798
)
Total derivatives related to VA contracts
(26,751
)
 
93,604

Derivatives related to FIA contracts:
 

 
 
Embedded derivative - FIA
(12,411
)
 
(2,162
)
Equity futures - FIA
297

 
1,382

Volatility futures - FIA
—

 
—

Equity options - FIA
10,700

 
(5,562
)
Total derivatives related to FIA contracts
(1,414
)
 
(6,342
)
Derivatives related to IUL contracts:
 

 
 
Embedded derivative - IUL
(2,090
)
 
(738
)
Equity futures - IUL
(799
)
 
(219
)
Equity options - IUL
2,891

 
(27
)
Total derivatives related to IUL contracts
2

 
(984
)
Embedded derivative - Modco reinsurance treaties
(17,865
)
 
(58,355
)
Derivatives with PLC(1)
(14,875
)
 
4,030

Other derivatives
3

 
(45
)
Total realized gains (losses) - derivatives
$
(60,900
)
 
$
31,908

 
 
 
 
(1) These derivatives include the Interest, YRT premium support, and portfolio maintenance agreements between certain of the Company’s subsidiaries and PLC.
 
The following table sets forth realized investments gains and losses for the Modco trading portfolio that is included in realized investment gains (losses) — all other investments:
Realized investment gains (losses) - all other investments
 
For The
Three Months Ended
March 31,
 
2017
 
2016
 
(Dollars In Thousands)
Modco trading portfolio(1)
$
18,552

 
$
78,154

 
 
 
 
(1) The Company elected to include the use of alternate disclosures for trading activities.

The following table presents the components of the gain or loss on derivatives that qualify as a cash flow hedging relationship. The Company did not have any derivatives that qualified as a cash flow hedging relationships for the three months ended March 31, 2016:
Gain (Loss) on Derivatives in Cash Flow Hedging Relationship
 
Amount of Gains (Losses)
Deferred in
Accumulated Other
Comprehensive Income
(Loss) on Derivatives
 
Amount and Location of
Gains (Losses)
Reclassified from
Accumulated Other
Comprehensive Income
(Loss) into Income (Loss)
 
Amount and Location of
(Losses) Recognized in
Income (Loss) on
Derivatives
 
(Effective Portion)
 
(Effective Portion)
 
(Ineffective Portion)
 
 
 
Benefits and settlement
expenses
 
Realized investment
gains (losses)
 
(Dollars In Thousands)
For The Three Months Ended March 31, 2017
 

 
 

 
 

Foreign currency swaps
$
(1,034
)
 
$
(205
)
 
$
—

Total
$
(1,034
)
 
$
(205
)
 
$
—


Based on expected cash flows of the underlying hedged items, the Company expects to reclassify $0.8 million out of accumulated other comprehensive income into earnings during the next twelve months.

The table below presents information about the nature and accounting treatment of the Company’s primary derivative financial instruments and the location in and effect on the consolidated condensed financial statements for the periods presented below:
 
As of
 
March 31, 2017
 
December 31, 2016
 
Notional
Amount
 
Fair
Value
 
Notional
Amount
 
Fair
Value
 
(Dollars In Thousands)
Other long-term investments
 

 
 

 
 

 
 

Cash flow hedges:
 
 
 
 
 
 
 
Foreign currency swaps
$
—

 
$
—

 
$
117,178

 
$
132

Derivatives not designated as hedging instruments:
 

 
 

 
 

 
 

Interest rate swaps
1,040,000

 
43,730

 
1,135,000

 
71,644

Derivatives with PLC(1)
2,780,731

 
34,004

 
2,808,807

 
48,878

Embedded derivative - Modco reinsurance treaties
64,310

 
616

 
64,123

 
2,573

Embedded derivative - GLWB
2,146,176

 
69,274

 
2,045,529

 
64,064

Interest rate futures
698,352

 
1,917

 
102,587

 
894

Equity futures
445,702

 
1,769

 
654,113

 
5,805

Currency futures
—

 
—

 
340,058

 
7,883

Equity options
4,459,031

 
363,614

 
3,944,444

 
328,908

Interest rate swaptions
225,000

 
1,034

 
225,000

 
2,503

Other
157

 
153

 
212

 
149

 
$
11,859,459

 
$
516,111

 
$
11,437,051

 
$
533,433

Other liabilities
 

 
 

 
 

 
 

Cash flow hedges:
 
 
 
 
 
 
 
Foreign currency swaps
$
117,178

 
$
485

 
$
—

 
$
—

Derivatives not designated as hedging instruments:
 

 
 

 
 

 
 

Interest rate swaps
822,500

 
1,953

 
575,000

 
10,208

Embedded derivative - Modco reinsurance treaties
2,437,200

 
150,924

 
2,450,692

 
141,301

Funds withheld derivative
1,556,518

 
72,041

 
1,557,237

 
91,267

Embedded derivative - GLWB
1,770,287

 
66,277

 
1,849,400

 
71,082

Embedded derivative - FIA
1,610,708

 
170,215

 
1,496,346

 
147,368

Embedded derivative - IUL
120,218

 
51,385

 
103,838

 
46,051

Interest rate futures
769,621

 
922

 
993,842

 
6,611

Equity futures
280,278

 
3,987

 
102,667

 
2,907

Currency futures
298,852

 
6,234

 
—

 
—

Equity options
3,020,620

 
201,838

 
2,590,160

 
157,253

 
$
12,803,980

 
$
726,261

 
$
11,719,182

 
$
674,048

 
 
 
 
 
 
 
 
(1) These derivatives include the Interest, YRT premium support, and portfolio maintenance agreements between certain of the Company’s subsidiaries and PLC.
During the first quarter 2016, the Company revised its methodology for estimating notional amounts associated with the YRT Support Agreements among certain of its affiliates. The Company's revised approach reflects its position that no reasonably estimable notional amounts exist for the YRT Support Agreements, which contain payment positions based on the movement of the underlying premium rates, as described in Note 5, Fair Value of Financial Instruments. Current period amounts disclosed above reflect this change in estimate, which did not impact the Company's financial position or results of operations.