Derivative Financial Instruments

6 Months Ended

Jun. 30, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

Note 9 — Derivative Financial Instruments

The Company uses derivative financial instruments to manage the characteristics ofinvestment assets to meet the varying demands of the related insurance and contractholder liabilities and to hedge long-term debt. The Company has written and purchased reinsurance contracts in its run-off reinsurance business that are accounted for as free standing derivatives. The Company alsoused derivative financial instruments to manage the equity, foreign currency, and certain interest rate risk exposures of its run-off reinsurance business until February 4, 2013 (for further information, see Note 5). For information on the Company's accounting policy for derivative financial instruments, see Note 2 to the Financial Statements contained in the Company's 2013 Form 10-K. Derivatives in the Company's separate accounts are excluded from the following discussion because associated gains and losses generally accrue directly to separate account policyholders.

Collateral and termination features.The Company routinely monitors exposure to credit risk associated with derivatives and diversifies the portfolio among approved dealers of high credit quality to minimize this risk. As of June 30, 2014, the Company had $19 million in cash on deposit representing the upfront margin required for the Company's centrally-cleared derivative instruments.Certain of the Company's over-the-counter derivative instruments contain provisions requiring either the Company or the counterparty to post collateral or demand immediate payment depending on the amount of the net liability position and predefined financial strength or credit rating thresholds. Collateral posting requirements vary by counterparty. The net liability positions of these derivatives were not material as of June 30, 2014 or December 31, 2013.

Derivative instruments used in the Company's investment and interest rate risk management.

The Company uses derivative financial instruments as a part of its investment strategy to manage the characteristics of investment assets (such as duration, yield, currency and liquidity) to meet the varying demands of the related insurance and contractholder liabilities (such as paying claims, investment returns and withdrawals). Derivatives are typically used in this strategy to reduce interest rate and foreign currency risks. The Company also uses derivative financial instruments to hedge interest rate risk on its long-term debt.

Investment Cash Flow Hedges

Purpose. The Company uses interest rate, foreign currency, and combination (interest rate and foreign currency) swap contracts to hedge the interest and foreign currency cash flows of its fixed maturity bonds to match associated insurance liabilities.

Accounting policy. Using cash flow hedge accounting, fair values are reported in other long-term investments or other liabilities. Changes in fair value are reported in accumulated other comprehensive income and amortized into net investment income or reported in other realized investment gains and losses as interest or principal payments are received.

Cash flows. Under the terms of these various contracts, the Company periodically exchanges cash flows between variable and fixed interest rates and/or between two currencies for both principal and interest. Foreign currency and combination swaps are primarily Euros,Australian dollars,Canadian dollars, Japanese yen, and British pounds, and have terms for periods of up to seven years. Net interest cash flows are reported in operating activities.

Volume of activity. The following table provides the notional values of these derivative instruments for the indicated periods:

	Notional Amount (In millions)
		As of		As of
Instrument		June 30, 2014		December 31, 2013
Interest rate swaps	$	44	$	45
Foreign currency swaps		111		118
Combination interest rate and foreign currency swaps		40		40
Total	$	195	$	203

The following table provides the effect of these derivative instruments on the financial statements for the indicated periods:

Fair Value Effect on the Financial Statements (In millions)
	Other Long-Term Investments (2)				Accounts Payable, Accrued Expenses and Other Liabilities (2)				Gain (Loss) Recognized in Other Comprehensive Income (1)
	As of June 30,		As of December 31,		As of June 30,		As of December 31,		For the three months ended June 30,				For the six months ended June 30,
Instrument	2014		2013		2014		2013		2014		2013		2014		2013
Interest rate swaps	$	1	$	2	$	-	$	-	$	-	$	-	$	(1)	$	(1)
Foreign currency swaps		1		1		12		13		-		-		2		4
Combination interest rate and foreign currency swaps		-		-		5		2		(1)		10		(2)		9
Total	$	2	$	3	$	17	$	15	$	(1)	$	10	$	(1)	$	12
(1) Other comprehensive income for foreign currency swaps excludes amounts required to adjust future policy benefits for the run-off settlement annuity business.
(2) There were no amounts offset in the Consolidated Balance Sheets at June 30, 2014 or December 31, 2013.

For the three months and six months ended June 30, 2014 and 2013, the amounts of gains (losses) reclassified from accumulated other comprehensive income into shareholders' net income were not material. No amounts were excluded from the assessment of hedge effectiveness and no gains (losses)were recognized due to hedge ineffectiveness.

Interest Rate Fair Value Hedges

Purpose. Beginning in 2014, the Company entered into centrally clearedinterest rate swap contracts to convert a portion of the interest rate exposure on its long-term debt from fixed to variable rates to more closely align interest expense with interest income received on its cash equivalent and short-term investment balances. The variable rates are benchmarked to LIBOR.

Accounting Policy. Using fair value hedge accounting, the fair values of the swap contracts are reported in other assets or other liabilities. As the critical terms of these swaps match those of the long-term debt being hedged, the carrying value of the hedged debt is adjusted to reflect changes in its fair value driven by LIBOR. The effects of those adjustments on other operating expense are offset by the effects of corresponding changes in the swaps' fair value. Interest expense includes the difference between the variable and fixed interest rates.

Cash flows. Under the terms of these contracts, the Company provides upfront margin and settles fair value changes and net interest between variable and fixed interest rates daily with the clearinghouse. Net interest cash flows are reported in operating activities.

Volume of activity. As of June 30, 2014, the notional values of these derivative instruments was $675 million.

For the three months ended June 30, 2014, interest expense included gains of $7 million for changes in the swap fair value and corresponding losses of $7 million to adjust the carrying value of the hedged debt. For the six months ended June 30, 2014, interest expense includedgains of $6 million for changes in the swap fair value and corresponding losses of $6 million to adjust the carrying value of the hedged debt.

As of June 30, 2014, the effects of these derivative instruments on the Consolidated Balance Sheets were not material.

Derivative instruments associated with the Company's run-off reinsurance business.

As explained in Note 5, the Company entered into an agreementin 2013 to effectively exit the GMIB and GMDB business. As a result, the following disclosures related to derivative instruments associated with the GMIB and GMDB business are provided for context, including a description of the derivative accounting for the GMIB contracts. Cash flows on derivative instruments associated with the GMIB and GMDB business are reported in operating activities.

Guaranteed Minimum Income Benefits (GMIB)

Purpose.The Company has written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees of minimum income benefits resulting from the level of variable annuity account values compared with a contractually guaranteed amount (“GMIB liabilities”). According to the contractual terms of the written reinsurance contracts, payment by the Company depends on the actual account value in the underlying mutual funds and the level of interest rates when the contractholders elect to receive minimum income payments.

The fair value effects of GMIB contracts on the financial statements are included in Note 7 and their volume of activity is included in Note 16. Further information on these contracts is also presented in Note 5.

GMDB and GMIB Hedge Programs

As a result of the reinsurance agreement with Berkshire to effectively exit the GMDB and GMIB business, the GMDB and GMIB hedge programs were terminated beginning February 4, 2013. See Note 5 for further details regarding this business.