DERIVATIVE FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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 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 variable annuity (“VA”) contracts, fixed indexed annuities, and indexed universal life contracts:

•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.

It is the Company's policy not to offset assets and liabilities associated with open derivative contracts. However, the Chicago Mercantile Exchange (“CME”) rules characterize variation margin transfers as settlement payments, as opposed to adjustments to collateral. As a result, derivative assets and liabilities associated with centrally cleared derivatives for which the CME serves as the central clearing party are presented as if these derivatives had been settled as of the reporting date.

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 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 flows paid on the note.

•To hedge a floating rate note, the Company entered into an interest rate swap to exchange the floating rate on the note for a fixed rate in order to hedge the interest rate risk associated with the note. The cash flows received on the swap are identical to the cash flow variability 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, YRT premium support agreements, and portfolio maintenance agreements with PLC.

•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 September 30,						For The Nine Months Ended September 30,
	2019		2018		2019		2018
	(Dollars In Thousands)
Derivatives related to VA contracts:
Interest rate futures	$	727	$	2,111	$	(16,575)	$	(13,229)
Equity futures	5,220		(5,733)		37,517		(23,025)
Currency futures	9,181		3,410		11,028		7,890
Equity options	(3,957)		(21,206)		(97,354)		(47,406)
Interest rate swaptions	—		—		—		(14)
Interest rate swaps	149,766		(41,288)		342,561		(131,147)
Total return swaps	(1,950)		(32,343)		(50,522)		(35,908)
Embedded derivative - GLWB	(86,635)		22,931		(189,624)		55,595
Funds withheld derivative	(350)		37,444		80,198		68,341
Total derivatives related to VA contracts	72,002		(34,674)		117,229		(118,903)
Derivatives related to FIA contracts:
Embedded derivative	(4,335)		(14,360)		(67,968)		(7,957)
Equity futures	962		(388)		964		(716)
Equity options	4,785		18,474		60,026		21,203
Total derivatives related to FIA contracts	1,412		3,726		(6,978)		12,530
Derivatives related to IUL contracts:
Embedded derivative	6,261		(9,535)		(18,395)		(877)
Equity futures	91		(1)		347		135
Equity options	586		4,928		9,372		5,764
Total derivatives related to IUL contracts	6,938		(4,608)		(8,676)		5,022
Embedded derivative - Modco reinsurance treaties	(44,027)		10,811		(199,704)		138,652
Derivatives with PLC⁽¹⁾	7,583		(1,913)		14,852		(66)
Other derivatives	(1,622)		(52)		(3,011)		(59)
Total realized gains (losses) - derivatives	$	42,286	$	(26,710)	$	(86,288)	$	37,176

(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 September 30, 2019
Foreign currency swaps	$	(4,163)	$	(373)	$	—
Interest rate swaps	(93)		(373)		—
Total	$	(4,256)	$	(746)	$	—

For The Nine Months Ended September 30, 2019
Foreign currency swaps	$	(7,789)	$	(767)	$	—
Interest rate swaps	(2,484)		(593)		—
Total	$	(10,273)	$	(1,360)	$	—

For The Three Months Ended September 30, 2018
Foreign currency swaps	$	190	$	(155)	$	—
Interest rate swaps	101		(326)		—
Total	$	291	$	(481)	$	—

For The Nine Months Ended September 30, 2018
Foreign currency swaps	$	3,772	$	(473)	$	—
Interest rate swaps	101		(326)		—
Total	$	3,873	$	(799)	$	—

Based on expected cash flows of the underlying hedged items, the Company expects to reclassify $3.3 million out of accumulated other comprehensive income (loss) 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
	September 30, 2019						December 31, 2018
	Notional Amount		Fair Value		Notional Amount		Fair Value
	(Dollars In Thousands)
Other long-term investments



Derivatives not designated as hedging instruments:
Interest rate swaps	$	2,228,000	$	131,894	$	1,515,500	$	28,501
Total return swaps	424,662		2,120		138,070		3,971
Derivatives with PLC⁽¹⁾	2,833,958		103,192		2,856,351		90,049
Embedded derivative - Modco reinsurance treaties	1,245,889		30,600		585,294		7,072
Embedded derivative - GLWB	965,140		59,248		1,919,861		54,221
Interest rate futures	844,428		8,256		286,208		10,302
Equity futures	322,478		2,425		12,633		483
Currency futures	271,290		2,316		—		—
Equity options	6,339,766		483,463		5,624,081		220,092

Other	—		—		157		136
	$	15,475,611	$	823,514	$	12,938,155	$	414,827
Other liabilities
Cash flow hedges:
Interest rate swaps	$	350,000	$	—	$	350,000	$	—
Foreign currency swaps	117,178		13,516		117,178		904
Derivatives not designated as hedging instruments:
Interest rate swaps	50,000		—		775,000		11,367
Total return swaps	126,177		916		768,177		23,054
Embedded derivative - Modco reinsurance treaties	2,283,624		245,792		1,795,287		32,828
Funds withheld derivative	2,073,724		93,707		1,992,562		95,142
Embedded derivative - GLWB	3,089,291		327,804		2,152,698		97,528
Embedded derivative - FIA	2,792,499		306,063		2,576,033		217,288
Embedded derivative - IUL	276,466		141,793		233,550		90,231
Interest rate futures	650,353		7,776		863,706		20,100
Equity futures	137,284		1,935		659,357		33,753
Currency futures	—		—		202,747		2,163
Equity options	4,169,543		239,814		4,199,687		34,178
Other	193,069		45,839		3,288		252
	$	16,309,208	$	1,424,955	$	16,689,270	$	658,788

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