4. DERIVATIVE INSTRUMENTS

We do not use derivative financial instruments for trading purposes, nor do we engage in leveraged derivative transactions. The majority of our freestanding derivatives are interest rate, foreign currency and credit default swaps that are associated with investments in special-purpose entities, including VIEs where we are the primary beneficiary. The remaining derivatives are interest rate swaps associated with our variable interest rate yen-denominated debt.

Derivative Types

Interest rate and credit default swaps involve the periodic exchange of cash flows with other parties, at specified intervals, calculated using agreed upon rates or other financial variables and notional principal amounts. Generally, no cash or principal payments are exchanged at the inception of the contract. Typically, at the time a swap is entered into, the cash flow streams exchanged by the counterparties are equal in value. Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed-maturity securities contracts to fixed rates. These derivatives are predominantly used to better match cash receipts from assets with cash disbursements required to fund liabilities.

Credit default swaps are used to assume credit risk related to an individual security or an index. These contracts entitle the consolidated VIE to receive a periodic fee in exchange for an obligation to compensate the derivative counterparty should the referenced security issuers experience a credit event, as defined in the contract. The consolidated VIE is also exposed to credit risk due to embedded derivatives associated with credit-linked notes.

Foreign currency swaps exchange an initial principal amount in two currencies, agreeing to re-exchange the currencies at a future date, at an agreed upon exchange rate. There may also be a periodic exchange of payments at specified intervals based on the agreed upon rates and notional amounts. Foreign currency swaps are used primarily in the consolidated VIEs in our Aflac Japan portfolio to convert foreign denominated cash flows to yen, the functional currency of Aflac Japan, in order to minimize cash flow fluctuations.

Credit Risk Assumed through Derivatives

Our exposure to credit risk in the event of nonperformance by the counterparty to our interest rate swap associated with our variable interest rate Samurai notes as of September 30, 2011, was immaterial. See the Hedging section of this Note for more information on this swap. For the interest rate, foreign currency, and credit default swaps associated with our VIE investments for which we are the primary beneficiary, we do not bear the risk of loss for counterparty default. We are not a direct counterparty to those contracts.

As a result of consolidation of certain VIE investments on January 1, 2010, we began recognizing related credit default swaps that assume credit risk from an asset pool. Those consolidated VIEs will receive periodic payments based on an agreed upon rate and notional amount and will only make a payment by delivery of associated collateral, which consists of highly rated asset-backed securities, if there is a credit event. A credit event payment will typically be equal to the notional value of the swap contract less the value of the referenced obligations. A credit event is generally defined as a default on contractually obligated interest or principal payments or bankruptcy of the referenced entity. The credit default swaps in which the consolidated VIE assumes credit risk primarily reference investment grade baskets. The diversified portfolios of corporate issuers are established within sector concentration limits.

The following tables present the maximum potential risk, fair value, weighted-average years to maturity, and underlying referenced credit obligation type for credit default swaps.


	September 30, 2011
	Less than one year				One to three years				Three to five years						Five to ten years						Total
(In millions)	Maximum potential risk		Estimated fair value		Maximum potential risk		Estimated fair value		Maximum potential risk			Estimated fair value			Maximum potential risk			Estimated fair value			Maximum potential risk			Estimated fair value
Index exposure:
Corporate bonds	$	0	$	0	$	0	$	0	$	(147	)	$	(21	)	$	(280	)	$	(173	)	$	(427	)	$	(194	)


	December 31, 2010
	Less than one year				One to three years				Three to five years						Five to ten years						Total
(In millions)	Maximum potential risk		Estimated fair value		Maximum potential risk		Estimated fair value		Maximum potential risk			Estimated fair value			Maximum potential risk			Estimated fair value			Maximum potential risk			Estimated fair value
Index exposure:
Corporate bonds	$	0	$	0	$	0	$	0	$	(340	)	$	(118	)	$	(416	)	$	(225	)	$	(756	)	$	(343	)

Derivative Balance Sheet Classification

The tables below summarize the balance sheet classification of our derivative fair value amounts, as well as the gross asset and liability fair value amounts. The fair value amounts presented do not include income accruals. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated. Notional amounts are not reflective of credit risk.


	September 30, 2011
(In millions)	Net Derivatives					Asset Derivatives		Liability Derivatives
Hedge Designation/ Derivative Type	Notional Amount		Fair Value			Fair Value		Fair Value
Cash flow hedges:
Interest rate swaps	$	72	$	0		$	0	$	0
Foreign currency swaps		75		31			31		0
Total cash flow hedges		147		31			31		0
Non-qualifying strategies:
Interest rate swaps		427		59			99		(40)
Foreign currency swaps		4,556		(97)			277		(374)
Credit default swaps		427		(194)			0		(194)
Total non-qualifying strategies		5,410		(232)			376		(608)
Total cash flow hedges and non-qualifying strategies	$	5,557	$	(201)		$	407	$	(608)

Balance Sheet Location
Other assets	$	1,666	$	407		$	407	$	0
Other liabilities		3,891		(608)			0		(608)
Total derivatives	$	5,557	$	(201)		$	407	$	(608)



	December 31, 2010
(In millions)	Net Derivatives					Asset Derivatives		Liability Derivatives
Hedge Designation/ Derivative Type	Notional Amount		Fair Value			Fair Value		Fair Value
Cash flow hedges:
Interest rate swaps	$	245	$	(2)		$	0	$	(2)
Foreign currency swaps		615		170			180		(10)
Total cash flow hedges		860		168			180		(12)
Non-qualifying strategies:
Interest rate swaps		743		56			124		(68)
Foreign currency swaps		3,815		(58)			260		(318)
Credit default swaps		756		(343)			0		(343)
Total non-qualifying strategies		5,314		(345)			384		(729)
Total cash flow hedges and non-qualifying strategies	$	6,174	$	(177)		$	564	$	(741)

Balance Sheet Location
Other assets	$	2,364	$	564		$	564	$	0
Other liabilities		3,810		(741	)		0		(741	)
Total derivatives	$	6,174	$	(177	)	$	564	$	(741	)

Hedging

Certain of our consolidated VIEs have interest rate and/or foreign currency swaps that qualify for hedge accounting treatment. For those that have qualified, we have designated the derivative as a hedge of the variability in cash flows of a forecasted transaction or of amounts to be received or paid related to a recognized asset (“cash flow” hedge). We expect to continue this hedging activity for a weighted-average period of approximately 14 years. The remaining derivatives in our consolidated VIEs that have not qualified for hedge accounting have been designated as held for other investment purposes (“non-qualifying strategies”).

We had interest rate swap agreements related to our 20 billion yen variable interest rate Uridashi notes that matured in September 2011, and we have an interest rate swap agreement related to our 5.5 billion yen variable interest rate Samurai notes that we issued in July 2011 (see Note 6). By entering into these contracts, we swapped the variable interest rate to a fixed interest rate of 1.52% for the Uridashi notes and 1.475% for the Samurai notes. We designated these interest rate swaps as a hedge of the variability in our interest cash flows associated with the respective variable interest rate notes. The notional amounts and terms of the swaps match the principal amount and terms of the corresponding variable interest rate notes, and the swaps had no value at inception. Changes in the fair value of the swap contracts are recorded in other comprehensive income so long as the hedge is deemed effective. Should any portion of the hedge be deemed ineffective, that value would be reported in net earnings.

Hedge Documentation and Effectiveness Testing

To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated changes in cash flow of the hedged item. At hedge inception, we formally document all relationships between hedging instruments and hedged items, as well as our risk-management objective and strategy for undertaking each hedge transaction. The documentation process includes linking derivatives that are designated as cash flow hedges to specific assets or liabilities on the statement of financial position or to specific forecasted transactions and defining the effectiveness and ineffectiveness testing methods to be used. At the hedge’s inception and on an ongoing quarterly basis, we also formally assess whether the derivatives that are used in hedging transactions have been and are expected to continue to be highly effective in offsetting changes in cash flows of hedged items. Hedge effectiveness is assessed using qualitative and quantitative methods. Qualitative methods may include the comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in cash flows associated with the hedge relationship. Hedge ineffectiveness of the hedge relationships is measured each reporting period using the “Hypothetical Derivative Method.”

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness are recognized in current earnings as a component of realized investment gains (losses). All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

Discontinuance of Hedge Accounting

We discontinue hedge accounting prospectively when (1) it is determined that the derivative is no longer highly effective in offsetting changes in the cash flows of a hedged item; (2) the derivative is de-designated as a hedging instrument; or (3) the derivative expires or is sold, terminated or exercised.

When hedge accounting is discontinued on a cash-flow hedge, including those where the derivative is sold, terminated or exercised, amounts previously deferred in other comprehensive income are reclassified into earnings when earnings are impacted by the cash flow of the hedged item.

Cash Flow Hedges

The following tables present the components of the gain or loss on derivatives that qualify as cash flow hedges:

Derivatives in Cash Flow Hedging Relationships


(In millions)	Gain (Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion)						Realized Investment Gains (Losses) Recognized in Income on Derivative (Ineffective Portion)
	Three Months Ended Sept 30, 2011			Nine Months Ended Sept 30, 2011			Three Months Ended Sept 30, 2011		Nine Months Ended Sept 30, 2011
Interest rate swaps	$	1		$	2		$	0	$	0
Foreign currency swaps		(1	)		(40	)		0		(2	)
Total	$	0		$	(38	)	$	0	$	(2	)

Derivatives in Cash Flow Hedging Relationships


(In millions)		Gain (Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion)					Realized Investment Gains (Losses) Recognized in Income on Derivative (Ineffective Portion)
	Three Months Ended September 30, 2010		Nine Months Ended September 30, 2010			Three Months Ended September 30, 2010		Nine Months Ended September 30, 2010
Interest rate swaps	$	0	$	1		$	0	$	0
Foreign currency swaps		2		(1	)		13		13
Total	$	2	$	0		$	13	$	13

In the third quarter of 2011, we de-designated certain of the foreign currency swaps with notional values totaling $500 million used in cash flow hedging strategies as a result of determining that these swaps would no longer be highly effective in offsetting the cash flows of the hedged item. As a result, the net gain recorded in accumulated other comprehensive income for these swaps that are no longer employing hedge accounting is being amortized into earnings over the expected life of the respective hedged item. The amount amortized from accumulated other comprehensive income into earnings related to these swaps was immaterial in the three-month period ended September 30, 2011. Furthermore, there was no gain or loss reclassified from accumulated other comprehensive income into earnings related to our designated cash flow hedges for the three- and nine-month periods ended September 30, 2011 and 2010. As of September 30, 2011, deferred net gains on derivative instruments recorded in accumulated other comprehensive income that are expected to be reclassified to earnings during the next twelve months are immaterial.

Non-qualifying Strategies

For our derivative instruments in consolidated VIEs that do not qualify for hedge accounting treatment, all changes in their fair value are reported in current period earnings as realized investment gains (losses). The following table presents the gain or loss recognized in income on non-qualifying strategies:

Non-qualifying Strategies

Gain (Loss) Recognized within Realized Investment Gains (Losses)


	Three Months Ended September 30,						Nine Months Ended September 30,
(In millions)	2011			2010			2011			2010
Interest rate swaps	$	(78	)	$	4		$	(79	)	$	7
Foreign currency swaps		(72	)		(33	)		(98	)		(77	)
Credit default swaps		(74	)		30			(112	)		(15	)
Total	$	(224	)	$	1		$	(289	)	$	(85	)

The amount of gain or loss recognized in earnings for our VIEs is attributable to the derivatives in those investment structures. While the change in value of the swaps is recorded through current period earnings, the change in value of the available-for-sale fixed income or perpetual securities associated with these swaps is recorded through other comprehensive income.

Nonderivative Hedges

Our primary exposure to be hedged is our net investment in Aflac Japan, which is affected by changes in the yen/dollar exchange rate. To mitigate this exposure, we have taken the following courses of action. First, Aflac Japan maintains an investment portfolio of dollar-denominated securities on behalf of Aflac U.S., which serves as an economic currency hedge of a portion of our investment in Aflac Japan. The functional currency for these investments is the U.S. dollar. The related investment income and realized/unrealized investment gains and losses are also denominated in U.S. dollars. The foreign exchange gains and losses related to this portfolio are taxable in Japan and the U.S. when the securities mature or are sold. Until maturity or sale, deferred tax expense or benefit associated with the foreign exchange gains or losses are recognized in other comprehensive income.

Second, we have designated a portion of the Parent Company’s yen-denominated liabilities (Samurai and Uridashi notes and yen-denominated loans - see Note 6) as nonderivative hedges of the foreign currency exposure of our investment in Aflac Japan. Our net investment hedge was effective during the three- and nine-month periods ended September 30, 2011, and 2010, respectively; therefore, there was no impact on net earnings during those periods for the foreign exchange effect of the designated Parent Company yen-denominated liabilities. There was no gain or loss reclassified from accumulated other comprehensive income into earnings related to our net investment hedge for the three- and nine-month periods ended September 30, 2011 and 2010, respectively.

For additional information on our financial instruments, see the accompanying Notes 1, 3 and 5 and Notes 1, 3 and 5 of the Notes to the Consolidated Financial Statements in our annual report to shareholders for the year ended December 31, 2010.