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Derivative Financial Instruments

9 Months Ended

Sep. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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, foreign currency risk, and credit risk. Historically, we have utilized current and forward interest rate swaps, current and forward currency swaps, forward benchmark interest rate locks, currency forward contracts, forward contracts on specific fixed income securities, and credit default swaps. Transactions hedging interest rate risk 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. We do not use derivative financial instruments for speculative purposes.

Derivatives designated as cash flow hedges and used to reduce our exposure to interest rate and duration risk 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. We use interest rate swaps 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.

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

Derivatives designated as fair value hedges and used to reduce our exposure to interest rate and duration risk 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.

Derivatives designated as either cash flow or fair value hedges and used to reduce our exposure to foreign currency risk are as follows:

•Foreign currency interest rate swaps are used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification. Under these swap agreements, 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.

Derivatives not designated as hedging instruments and used to reduce our exposure to foreign currency risk and credit losses on securities owned are as follows:

•Foreign currency interest rate swaps previously designated as hedges were used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification. These derivatives were effective hedges prior to novation to a new counterparty. In conjunction with the novation, these derivatives were de-designated as hedges. 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. We hold offsetting swaps wherein we agree to pay fixed rate principal and interest payments in the functional currency of the operating segment in exchange for fixed rate foreign currency-denominated payments.

•Credit default swaps are used as economic hedges against credit risk but do not qualify for hedge accounting. A credit default swap is an agreement in which we agree with another party to pay, at specified intervals, a fixed-rate fee in exchange for insurance against a credit event on a specific investment. If a defined credit event occurs, our counterparty may either pay us a net cash settlement, or we may surrender the specific investment to them in exchange for cash equal to the full notional amount of the swap. Credit events typically include events such as bankruptcy, failure to pay, or certain types of debt restructuring.

•Foreign currency forward contracts are used to minimize foreign currency risk. 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 currency risk arising from foreign-currency denominated securities.

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. Credit exposure on derivatives is limited to the value of those contracts in a net gain position, including accrued interest receivable less collateral held. As of September 30, 2020, our credit exposure on derivatives was de minimis. At December 31, 2019, we had no credit exposure on derivatives. The table below summarizes the nature and amount of collateral received from and posted to our derivative counterparties.


	September 30, 2020		December 31, 2019
	(in millions of dollars)
Carrying Value of Collateral Received from Counterparties
Cash	$	34.3	$	24.0
Carrying Value of Collateral Posted to Counterparties
Fixed Maturity Securities	$	30.4	$	28.6

See Note 4 for further discussion of our master netting agreements.

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 $34.0 million and $34.6 million at September 30, 2020 and December 31, 2019, respectively.

Derivative Transactions

The table below summarizes, by notional amounts, the activity for each category of derivatives. The notional amounts represent the basis upon which our counterparty pay and receive amounts are calculated.


	Swaps
		Receive Fixed/Pay Fixed		Receive Fixed/Pay Variable		Credit Default		Forwards		Total
	(in millions of dollars)
Balance at June 30, 2019		$	558.8	$	250.0	$	10.9	$	—	$	819.7
Additions		22.0		—		—		358.9		380.9
Terminations		13.5		—		—		256.0		269.5
Foreign Currency		—		—		(0.3)		—		(0.3)
Balance at September 30, 2019		$	567.3	$	250.0	$	10.6	$	102.9	$	930.8

Balance at December 31, 2018		$	538.2	$	250.0	$	11.0	$	—	$	799.2
Additions		121.6		—		—		382.4		504.0
Terminations		92.5		—		—		279.1		371.6
Foreign Currency		—		—		(0.4)		(0.4)		(0.8)
Balance at September 30, 2019		$	567.3	$	250.0	$	10.6	$	102.9	$	930.8

Balance at June 30, 2020		$	663.1	$	250.0	$	10.7	$	7.6	$	931.4
Additions		40.4		—		—		2.7		43.1
Terminations		3.3		250.0		—		—		253.3
Foreign Currency		—		—		0.4		—		0.4
Balance at September 30, 2020		$	700.2	$	—	$	11.1	$	10.3	$	721.6

Balance at December 31, 2019		$	611.1	$	250.0	$	11.4	$	8.9	$	881.4
Additions		92.4		—		—		2.7		95.1
Terminations		3.3		250.0		—		1.3		254.6
Foreign Currency		—		—		(0.3)		—		(0.3)
Balance at September 30, 2020		$	700.2	$	—	$	11.1	$	10.3	$	721.6

Cash Flow Hedges

As of September 30, 2020 and December 31, 2019, we had $210.2 million and $213.5 million notional amount of receive fixed, pay fixed, open current and forward foreign currency interest rate swaps to hedge fixed income foreign currency-denominated securities.

During the third quarter of 2019, we entered into a $350.0 million notional forward benchmark interest rate lock in order to hedge the interest rate risk associated with the cash flows related to the tender offer and early redemption of certain of our debt securities. We terminated $256.0 million notional of the interest rate lock in the third quarter of 2019 for the debt securities that were tendered and recognized a loss of $0.6 million that was reported with the $3.8 million tender premium in the third quarter of 2019 as a cost related to the early retirement of debt in our statement of income.

As of September 30, 2020, we expect to amortize approximately $72.8 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. Additional amounts that may 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 September 30, 2020, we are hedging the variability of future cash flows associated with forecasted transactions through the year 2045.

Fair Value Hedges

As of September 30, 2020 and December 31, 2019, we had $341.8 million and $249.4 million notional amount of receive fixed, pay fixed, open current and forward foreign currency interest rate swaps to hedge fixed income foreign currency-denominated securities.

At December 31, 2019, we had $250.0 million notional amount of receive fixed, pay variable interest rate swaps to hedge the changes in the fair value of certain fixed rate long-term debt which matured in the third quarter of 2020 along with the hedged debt. These swaps effectively converted the associated fixed rate long-term debt into floating rate debt and provided for a better matching of interest rates with our short-term investments, which have frequent interest rate resets similar to a floating rate security.

The following table summarizes the carrying amount of hedged assets and liabilities and the related cumulative basis adjustments related to our fair value hedges:


	Carrying Amount of Hedged Assets (Liabilities)						Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets (Liabilities)
	September 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019
	(in millions of dollars)
Fixed maturity securities:

Receive fixed functional currency interest, pay fixed foreign currency interest	$	290.6	$	239.4	$	7.9	$	1.1

Long-term Debt	$	—	$	(249.2)	$	—	$	0.6

For the three and nine months ended September 30, 2020, $(10.2) million and $14.1 million, respectively, of the derivative instruments' gain or loss was excluded from the assessment of hedge effectiveness. For the three and nine months ended September 30, 2019, $(0.6) million and $0.9 million, respectively, 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

As of September 30, 2020 and December 31, 2019, we held $148.2 million notional amount of receive fixed, pay fixed, foreign currency interest rate swaps. These derivatives are not designated as hedges, and as such, changes in fair value related to these derivatives are reported in earnings as a component of net realized investment gain or loss.

As of September 30, 2020 and December 31, 2019, we held $11.1 million and $11.4 million, respectively, notional amount of single name credit default swaps. We entered into these swaps in order to mitigate the credit risk associated with specific securities owned.

As of September 30, 2020 and December 31, 2019, we held $10.3 million and $8.9 million, respectively, notional amount of foreign currency forwards to mitigate the foreign currency risk associated with specific securities owned.

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.


	September 30, 2020
	Derivative Assets				Derivative Liabilities
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
	(in millions of dollars)
Designated as Hedging Instruments
Cash Flow Hedges

Foreign Exchange Contracts	Other L-T Investments	$	23.6	Other Liabilities	$	5.3


Fair Value Hedges

Foreign Exchange Contracts	Other L-T Investments	14.4		Other Liabilities	4.6


Total Designated as Hedging Instruments		$	38.0		$	9.9

Not Designated as Hedging Instruments
Credit Default Swaps	Other L-T Investments	$	0.2	Other Liabilities	$	—

Forwards	Other L-T Investments	0.1		Other Liabilities	—
Foreign Exchange Contracts	Other L-T Investments	—		Other Liabilities	24.1
Embedded Derivative in Modified Coinsurance Arrangement	Other L-T Investments	—		Other Liabilities	53.7
Total Not Designated as Hedging Instruments		$	0.3		$	77.8


	December 31, 2019
	Derivative Assets				Derivative Liabilities
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
	(in millions of dollars)
Designated as Hedging Instruments
Cash Flow Hedges

Foreign Exchange Contracts	Other L-T Investments	$	19.4	Other Liabilities	$	6.6


Fair Value Hedges
Interest Rate Swaps	Other L-T Investments	—		Other Liabilities	0.6
Foreign Exchange Contracts	Other L-T Investments	7.6		Other Liabilities	5.0
Total Fair Value Hedges		7.6			5.6

Total Designated as Hedging Instruments		$	27.0		$	12.2

Not Designated as Hedging Instruments
Credit Default Swaps	Other L-T Investments	$	0.5	Other Liabilities	$	—

Foreign Exchange Contracts	Other L-T Investments	—		Other Liabilities	22.4
Embedded Derivative in Modified Coinsurance Arrangement	Other L-T Investments	—		Other Liabilities	22.8
Total Not Designated as Hedging Instruments		$	0.5		$	45.2

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


	Three Months Ended September 30
	2020										2019
	Net Investment Income		Net Realized Investment Gain (Loss)		Interest and Debt Expense		Net Investment Income		Net Realized Investment Gain (Loss)		Interest and Debt Expense
	(in millions of dollars)
Total Income and Expense Presented in the Consolidated Statements of Income of Which Hedged Items are Recorded	$	613.2	$	4.4	$	49.4	$	599.4	$	(26.2)	$	46.1

Gain (Loss) on Cash Flow Hedging Relationships
Interest Rate Swaps:
Hedged items	72.1		—		7.3		74.5		1.7		7.7
Derivatives Designated as Hedging Instruments	18.6		—		0.4		18.8		5.3		0.6
Foreign Exchange Contracts:
Hedged items	2.4		(0.1)		—		3.3		(0.8)		—
Derivatives Designated as Hedging Instruments	0.8		0.1		—		(0.3)		0.7		—

Gain (Loss) on Fair Value Hedging Relationships
Interest Rate Swaps:
Hedged items	—		0.6		2.9		—		(0.6)		3.5
Derivatives Designated as Hedging Instruments	—		(0.6)		(0.6)		—		0.6		0.6
Foreign Exchange Contracts
Hedged items	1.8		9.7		—		0.6		(4.8)		—
Derivatives Designated as Hedging Instruments	(0.1)		(9.7)		—		0.5		4.8		—


	Nine Months Ended September 30
	2020										2019
	Net Investment Income		Net Realized Investment Gain (Loss)		Interest and Debt Expense		Net Investment Income		Net Realized Investment Gain (Loss)		Interest and Debt Expense
	(in millions of dollars)
Total Income and Expense Presented in the Consolidated Statements of Income of Which Hedged Items are Recorded	$	1,767.2	$	(105.8)	$	142.6	$	1,819.0	$	(32.4)	$	130.8

Gain (Loss) on Cash Flow Hedging Relationships
Interest Rate Swaps:
Hedged items	218.1		0.1		21.9		222.0		(1.2)		23.1
Derivatives Designated as Hedging Instruments	57.5		0.4		1.7		54.4		9.3		1.8
Foreign Exchange Contracts:
Hedged items	8.5		(0.1)		—		11.6		1.1		—
Derivatives Designated as Hedging Instruments	2.1		0.1		—		(0.9)		(1.0)		—

Gain (Loss) on Fair Value Hedging Relationships
Interest Rate Swaps:
Hedged items	—		(0.6)		10.1		—		(4.2)		10.7
Derivatives Designated as Hedging Instruments	—		0.6		(0.9)		—		4.2		2.1
Foreign Exchange Contracts
Hedged items	5.0		6.8		—		1.5		(4.0)		—
Derivatives Designated as Hedging Instruments	2.0		(6.8)		—		1.2		4.0		—

The following table summarizes the location of gains and losses of derivative financial instruments designated as cash flow hedging instruments, as reported in our consolidated statements of comprehensive income (loss).


		Three Months Ended September 30												Nine Months Ended September 30
		2020				2019				2020				2019
		(in millions of dollars)
Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives
Interest Rate Swaps and Forwards				$	—			$	(0.1)			$	—			$	(0.2)

Foreign Exchange Contracts				(5.6)				6.7				6.0				(4.0)
	Total	$	(5.6)			$	6.6			$	6.0			$	(4.2)

The following table summarizes the location of gains and losses on our derivatives not designated as hedging instruments, as reported in our consolidated statements of income.


		Three Months Ended September 30						Nine Months Ended September 30
		2020		2019		2020		2019
		(in millions of dollars)
Net Realized Investment Gain (Loss)
	Credit Default Swaps	$	(0.3)	$	0.2	$	(0.4)	$	(0.4)

	Foreign Exchange Contracts	(0.3)		(0.2)		(1.9)		(0.3)
	Embedded Derivative in Modified Coinsurance Arrangement	14.1		(11.1)		(30.9)		(6.4)
	Total	$	13.5	$	(11.1)	$	(33.2)	$	(7.1)