Derivative Financial Instruments

Purpose of Derivatives

We are exposed to certain risks relating to our ongoing business operations. The primary risks managed by using derivative instruments are interest rate risk, risk related to matching duration for our assets and liabilities, and foreign currency risk. Historically, we have utilized current and forward interest rate swaps and options on forward interest rate swaps, current and forward currency swaps, forward treasury locks, currency forward contracts, and forward contracts on specific fixed income securities. Hedging transactions are primarily associated with our individual and group long-term care and individual and group disability products. All other product portfolios are periodically reviewed to determine if hedging strategies would be appropriate for risk management purposes.

Our cash flow hedging programs are as follows:

•

Interest rate swaps are used to hedge interest rate risks and to improve the matching of assets and liabilities. An interest rate swap is an agreement in which we agree with other parties to exchange, at specified intervals, the difference between fixed rate and variable rate interest amounts. The purpose of these swaps is to hedge the anticipated purchase of fixed maturity securities thereby protecting us from the potential adverse impact of declining interest rates on the associated policy reserves. We also use interest rate swaps to hedge the potential adverse impact of rising interest rates in anticipation of issuing fixed rate long-term debt.

•

Foreign currency interest rate swaps have historically been used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification and to hedge the currency risk associated with certain of the interest payments and debt repayments of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries. For hedges of fixed maturity securities, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the operating segment. For hedges of debt issued, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments to the counterparty in exchange for fixed rate U.S. dollar-denominated interest payments.


•	Options on forward interest rate swaps are used to hedge the interest rate risk on certain insurance liabilities with minimum interest rate guarantees. By purchasing options on interest rate swaps, we are able to lock in the minimum investment yields needed to meet the required interest rate guarantee on the insurance liabilities.


•	Forward treasury locks are used to minimize interest rate risk associated with the anticipated purchase or disposal of fixed maturity securities. A forward treasury lock is a derivative contract without an initial investment where we and the counterparty agree to purchase or sell a specific U.S. Treasury bond at a future date at a pre-determined price.

•

Foreign currency forward contracts are used to minimize foreign currency risks. A foreign currency forward is a derivative without an initial investment where we and the counterparty agree to exchange a specific amount of currencies, at a specific exchange rate, on a specific date. We use these forward contracts to hedge the foreign currency risk associated with certain of the debt repayments of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries and to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for diversification purposes.

Our fair value hedging programs are as follows:

•

Interest rate swaps are used to effectively convert certain of our fixed rate securities into floating rate securities which are used to fund our floating rate long-term debt. Under these swap agreements, we receive a variable rate of interest and pay a fixed rate of interest. Additionally, we use interest rate swaps to effectively convert certain fixed rate long-term debt into floating rate long-term debt. Under these swap agreements, we receive a fixed rate of interest and pay a variable rate of interest.

Derivative Risks

The basic types of risks associated with derivatives are market risk (that the value of the derivative will be adversely impacted by changes in the market, primarily the change in interest and exchange rates) and credit risk (that the counterparty will not perform according to the terms of the contract). The market risk of the derivatives should generally offset the market risk associated with the hedged financial instrument or liability.

To help limit the credit exposure of the derivatives, we enter into master netting agreements with our counterparties whereby contracts in a gain position can be offset against contracts in a loss position. We also typically enter into bilateral, cross-collateralization agreements with our counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss

position meets or exceeds an agreed upon amount. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position less collateral held, was $2.3 million at June 30, 2011. We held no cash collateral from our counterparties as of June 30, 2011. We held cash collateral of $39.1 million from our counterparties as of December 31, 2010. This unrestricted cash collateral is included in short-term investments, and the associated obligation to return the collateral to our counterparties is included in other liabilities in our consolidated balance sheets. We post either fixed maturity securities or cash as collateral to our counterparties. The carrying value of fixed maturity securities posted as collateral to our counterparties was $153.1 million and $158.8 million at June 30, 2011 and December 31, 2010, respectively. We had no cash posted as collateral to our counterparties at June 30, 2011 and December 31, 2010.

The majority of our derivative instruments contain provisions that require us to maintain specified issuer credit ratings and financial strength ratings. Should our ratings fall below these specified levels, we would be in violation of the provisions, and our derivatives counterparties could terminate our contracts and request immediate payment. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a liability position was $203.6 million and $199.6 million at June 30, 2011 and December 31, 2010, respectively.

Hedging Activity

The table below summarizes by notional amounts the activity for each category of derivatives.



	Swaps
	Receive Variable/Pay Fixed		Receive Fixed/Pay Fixed		Receive Fixed/Pay Variable		Forwards		Total
			(in millions of dollars)
Balance at March 31, 2011	$	174.0	$	606.9	$	835.0	$	—	$	1,615.9
Additions	—		—		—		12.0		12.0
Terminations	—		27.2		50.0		12.0		89.2
Balance at June 30, 2011	$	174.0	$	579.7	$	785.0	$	—	$	1,538.7

Balance at December 31, 2010	$	174.0	$	617.9	$	890.0	$	—	$	1,681.9
Additions	—		—		—		31.9		31.9
Terminations	—		38.2		105.0		31.9		175.1
Balance at June 30, 2011	$	174.0	$	579.7	$	785.0	$	—	$	1,538.7

The following table summarizes the timing of anticipated settlements of interest rate swaps outstanding under our cash flow hedging programs at June 30, 2011, whereby we receive a fixed rate and pay a variable rate. The weighted average variable interest rates assume current market conditions.



	2011			2012			2013			Total
				(in millions of dollars)
Notional Value	$	100.0		$	185.0		$	150.0		$	435.0
Weighted Average Receive Rate	5.14		%	6.49		%	6.34		%	6.13		%
Weighted Average Pay Rate	0.25		%	0.25		%	0.25		%	0.25		%

Cash Flow Hedges

As of June 30, 2011 and December 31, 2010, we had $435.0 million and $540.0 million, respectively, notional amount of forward starting interest rate swaps to hedge the anticipated purchase of fixed maturity securities.

As of June 30, 2011 and December 31, 2010, we had $579.7 million and $617.9 million, respectively, notional amount of open current and forward foreign currency swaps to hedge fixed income foreign dollar-denominated securities.

During the six months ended June 30, 2011, we entered into $31.9 million notional amount of forward treasury locks used to minimize interest rate risk associated with the anticipated disposal of certain fixed maturity securities. The treasury locks were terminated at the time the securities were called and/or sold, and we recognized a gain of $0.1 million on the termination of these hedges during the six months ended June 30, 2011. The gain was recognized in other comprehensive income and amortized into net investment income.

For the six months ended June 30, 2011, there was no material ineffectiveness related to our cash flow hedges, and no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness.

As of June 30, 2011, we expect to amortize approximately $32.0 million of net deferred gains on derivative instruments during the next twelve months. This amount will be reclassified from accumulated other comprehensive income into earnings and reported on the same income statement line item as the hedged item. The income statement line items that will be affected by this amortization are net investment income and interest and debt expense. The estimated amortization includes the impact of certain derivative contracts that have not yet been terminated as of June 30, 2011. Fluctuations in fair values of these derivatives between June 30, 2011 and the date of termination will vary our projected amortization. Amounts that will be reclassified from accumulated other comprehensive income into earnings to offset the earnings impact of foreign currency translation of hedged items are not estimable.

As of June 30, 2011, we are hedging the variability of future cash flows associated with forecasted transactions through the year 2038.

Fair Value Hedges

As of June 30, 2011 and December 31, 2010, we had $174.0 million notional amount of receive variable, pay fixed interest rate swaps to hedge the changes in fair value of certain fixed rate securities held. These swaps effectively convert the associated fixed rate securities into floating rate securities, which are used to fund our floating rate long-term debt. Changes in the fair value of the derivative and changes in the fair value of the hedged item attributable to the risk being hedged are recognized in current earnings as a component of net realized investment gain or loss during the period of change in fair value. For the six months ended June 30, 2011 and 2010, the change in fair value of the hedged fixed maturity securities attributable to the hedged benchmark interest rate resulted in gains of $1.1 million and $10.6 million, respectively, with offsetting losses on the related interest rate swaps.

As of June 30, 2011 and December 31, 2010, we had a $350.0 million notional amount receive fixed, pay variable interest rate swap to hedge the changes in the fair value of certain fixed rate long-term debt. This swap effectively converts the associated fixed rate long-term debt into floating rate debt and provides for a better matching of interest rates with our short-term investments, which have frequent interest rate resets similar to a floating rate security. For the six months ended June 30, 2011, the change in fair value of the hedged fixed debt attributable to the hedged benchmark interest rate resulted in a loss of $7.2 million, with an offsetting gain on the related interest rate swaps.

For the six months ended June 30, 2011 and 2010, there was no material ineffectiveness related to our fair value hedges, and no component of the derivative instruments’ gain or loss was excluded from the assessment of hedge effectiveness. There were no instances wherein we discontinued fair value hedge accounting due to a hedged firm commitment no longer qualifying as a fair value hedge.

Derivatives Not Designated as Hedging Instruments

We have an embedded derivative in a modified coinsurance arrangement for which we include in our realized investment gains and losses a calculation intended to estimate the value of the option of our reinsurance counterparty to cancel the reinsurance contract with us. However, neither party can unilaterally terminate the reinsurance agreement except in extreme circumstances resulting from regulatory supervision, delinquency proceedings, or other direct regulatory action. Cash settlements or collateral related to this embedded derivative are not required at any time during the reinsurance contract or at termination of the reinsurance contract. There are no credit-related counterparty triggers, and any accumulated embedded derivative gain or loss reduces to zero over time as the reinsured business winds down.

Locations and Amounts of Derivative Financial Instruments

The following tables summarize the location and fair values of derivative financial instruments, as reported in our consolidated balance sheets.



	June 30, 2011
	(in millions of dollars)
	Asset Derivatives			Liability Derivatives
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Designated as Hedging Instruments
Interest Rate Swaps	Other L-T Investments	$	84.8	Other Liabilities	$	33.2
Foreign Exchange Contracts	Other L-T Investments	0.2		Other Liabilities	170.4
Total		$	85.0		$	203.6

Not Designated as Hedging Instruments
Embedded Derivative in Modified Coinsurance Arrangement				Other Liabilities	$	87.0



	December 31, 2010
	(in millions of dollars)
	Asset Derivatives			Liability Derivatives
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Designated as Hedging Instruments
Interest Rate Swaps	Other L-T Investments	$	98.4	Other Liabilities	$	39.1
Foreign Exchange Contracts	Other L-T Investments	0.7		Other Liabilities	160.5
Total		$	99.1		$	199.6

Not Designated as Hedging Instruments
Embedded Derivative in Modified Coinsurance Arrangement				Other Liabilities	$	96.3

The following tables summarize the location of and gains and losses on derivative financial instruments designated as cash flow hedging instruments, as reported in our consolidated statements of income and consolidated statements of comprehensive income.



	Three Months Ended June 30, 2011
	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion)			Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)				Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion)
	(in millions of dollars)
Interest Rate Swaps and Forwards	$	12.8		$	9.0		(1)	$	—
Interest Rate Swaps	—			0.6			(2)	—
Interest Rate Swaps	—			(0.4		)	(3)	—
Foreign Exchange Contracts	—			(0.3		)	(1)	—
Foreign Exchange Contracts	(2.6		)	(6.1		)	(2)	—
Total	$	10.2		$	2.8			$	—


(1)	Gain (loss) recognized in net investment income


(2)	Gain (loss) recognized in net realized investment gain (loss)


(3)	Loss recognized in interest and debt expense



	Three Months Ended June 30, 2010
	Gain Recognized in OCI on Derivatives (Effective Portion)		Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)				Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion)
	(in millions of dollars)
Interest Rate Swaps and Forwards	$	11.7	$	7.7		(1)	$	—
Interest Rate Swaps	—		0.8			(2)	—
Interest Rate Swaps	—		(0.1		)	(4)	—
Foreign Exchange Contracts	—		(0.5		)	(1)	—
Foreign Exchange Contracts	55.8		31.6			(2)	—
Foreign Exchange Contracts	—		0.6			(3)	—
Total	$	67.5	$	40.1			$	—


(1)	Gain (loss) recognized in net investment income


(2)	Gain recognized in net realized investment gain (loss)


(3)	Gain recognized in interest and debt expense


(4)	Loss recognized in other income



	Six Months Ended June 30, 2011
	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion)			Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)				Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion)
	(in millions of dollars)
Interest Rate Swaps and Forwards	$	27.4		$	17.4		(1)	$	—
Interest Rate Swaps	—			1.8			(2)	—
Interest Rate Swaps	—			(0.8		)	(3)	—
Foreign Exchange Contracts	—			(0.6		)	(1)	—
Foreign Exchange Contracts	(10.5		)	(24.6		)	(2)	—
Total	$	16.9		$	(6.8	)		$	—


(1)	Gain (loss) recognized in net investment income


(2)	Gain (loss) recognized in net realized investment gain (loss)


(3)	Loss recognized in interest and debt expense



	Six Months Ended June 30, 2010
	Gain Recognized in OCI on Derivatives (Effective Portion)		Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)				Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion)
	(in millions of dollars)
Interest Rate Swaps and Forwards	$	24.5	$	15.6		(1)	$	—
Interest Rate Swaps	—		2.6			(2)	—
Interest Rate Swaps	—		(0.1		)	(4)	—
Foreign Exchange Contracts	—		(1.1		)	(1)	—
Foreign Exchange Contracts	30.6		13.5			(2)	—
Foreign Exchange Contracts	—		1.2			(3)	—
Total	$	55.1	$	31.7			$	—


(1)	Gain (loss) recognized in net investment income


(2)	Gain recognized in net realized investment gain (loss)


(3)	Gain recognized in interest and debt expense


(4)	Loss recognized in other income

The following table summarizes the location of and gains and losses on our embedded derivative in a modified coinsurance arrangement, as reported in our consolidated statements of income.



	Three Months Ended June 30						Six Months Ended June 30
	2011			2010			2011		2010
	(in millions of dollars)
Gain (Loss) Recognized in Net Realized Investment Gain (Loss)	$	(4.8	)	$	(23.6	)	$	9.3	$	(5.3	)