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 futures, equity options, total return swaps, interest rate futures, interest rate swaps, interest rate swaptions, currency futures, volatility futures, volatility options, and variance swaps 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 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 as it is, 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 as it is, 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,
	2018			2017
	(Dollars In Thousands)
Derivatives related to VA contracts:
Interest rate futures - VA	$	(16,892	)	$	3,448
Equity futures - VA	(6,428		)	(30,817		)
Currency futures - VA	(7,583		)	(6,256		)
Equity options - VA	12,016			(40,185		)
Interest rate swaptions - VA	(14		)	(1,469		)
Interest rate swaps - VA	(63,710		)	(8,957		)
Total return swaps - VA	6,490			—
Embedded derivative - GLWB	21,473			10,016
Funds withheld derivative	(7,957		)	47,469
Total derivatives related to VA contracts	(62,605		)	(26,751		)
Derivatives related to FIA contracts:
Embedded derivative - FIA	11,330			(12,411		)
Equity futures - FIA	(161		)	297
Equity options - FIA	(4,669		)	10,700
Total derivatives related to FIA contracts	6,500			(1,414		)
Derivatives related to IUL contracts:
Embedded derivative - IUL	9,884			(2,090		)
Equity futures - IUL	136			(799		)
Equity options - IUL	(1,250		)	2,891
Total derivatives related to IUL contracts	8,770			2
Embedded derivative - Modco reinsurance treaties	82,658			(17,865		)
Derivatives with PLC⁽¹⁾	11,543			(14,875		)
Other derivatives	(40		)	3
Total realized gains (losses) - derivatives	$	46,826		$	(60,900	)

(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 presents the components of the gain or loss on derivatives that qualify as a cash flow hedging relationship.

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, 2018
Foreign currency swaps	$	615		$	(113	)	$	—
Total	$	615		$	(113	)	$	—

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 $0.4 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, 2018				December 31, 2017
	Notional Amount		Fair Value		Notional Amount		Fair Value
	(Dollars In Thousands)
Other long-term investments
Cash flow hedges:
Foreign currency swaps	$	117,178	$	12,131	$	117,178	$	6,016
Derivatives not designated as hedging instruments:
Interest rate swaps	1,065,000		25,943		1,265,000		55,411
Total return swaps	448,872		18,678		190,938		135
Derivatives with PLC⁽¹⁾	2,851,231		103,121		2,810,469		91,578
Embedded derivative - Modco reinsurance treaties	64,798		497		64,472		1,009
Embedded derivative - GLWB	2,286,032		72,741		2,116,935		67,879
Interest rate futures	375,718		8,059		1,071,870		3,178
Equity futures	272,807		11,218		62,266		154
Currency futures	150,801		1,127		1,117		2
Equity options	5,168,294		365,097		4,436,467		403,961
Interest rate swaptions	225,000		—		225,000		14
Other	157		160		157		200
	$	13,025,888	$	618,772	$	12,361,869	$	629,537
Other liabilities
Derivatives not designated as hedging instruments:
Interest rate swaps	$	997,500	$	12,157	$	597,500	$	2,960
Total return swaps	—		—		243,388		318
Embedded derivative - Modco reinsurance treaties	2,375,807		126,090		2,390,539		215,247
Funds withheld derivative	1,682,018		101,773		1,502,726		61,729
Embedded derivative - GLWB	1,777,894		66,816		1,939,320		83,427
Embedded derivative - FIA	2,109,420		218,340		1,951,650		218,676
Embedded derivative - IUL	186,173		77,350		168,349		80,212
Interest rate futures	872,564		4,630		230,404		917
Equity futures	95,918		1,288		318,795		2,593
Currency futures	95,062		971		255,248		2,087
Equity options	3,623,922		177,557		3,112,812		237,807
	$	13,816,278	$	786,972	$	12,710,731	$	905,973

(1) These derivatives include the Interest, YRT premium support, and portfolio maintenance agreements between certain of the Company’s subsidiaries and PLC.