Reinsurance

9 Months Ended

Sep. 30, 2017

Note 8 ― Reinsurance

The Company’s insurance subsidiaries enter into agreements with other insurance companies to assume and cede reinsurance. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct or assumed losses. Reinsurance is also used in acquisition and disposition transactions when the underwriting company is not being acquired. Reinsurance does not relieve the originating insurer of liability. The Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of its credit risk.

Reinsurance Recoverables

The majority of the Company’s reinsurance recoverables resulted from acquisition and disposition transactions in which the underwriting company was not acquired. Components of the Company’s reinsurance recoverables are presented below:

(In millions)
			September 30,		December 31,		Collateral and Other Terms
Line of Business		Reinsurer(s)	2017		2016		at September 30, 2017
Ongoing operations:
	Global Health Care, Global Supplemental Benefits, Group Disability and Life, COLI	Various	$	450	$	478	Recoverables from approximately 80 reinsurers, used in the ordinary course of business. Current balances range from less than $1 million up to $84 million. Over 70% of the balance is from companies rated as investment grade by Standard & Poor's, and 12% is secured by assets in trusts or letters of credit.
	Total recoverables related to ongoing operations			450		478
Acquisition, disposition or runoff activities:
	Individual Life and Annuity (sold in 1998)	Lincoln National Life and Lincoln Life & Annuity of New York		3,463		3,586	Both companies' ratings are sufficient to avoid triggering a contractual obligation to fully secure the outstanding balance.
	GMDB	Berkshire		989		1,085	100% secured by assets in a trust.
		Other		37		44	100% secured by assets in a trust or letters of credit.
	Retirement Benefits Business (sold in 2004)	Prudential Retirement Insurance and Annuity		870		921	100% secured by assets in a trust.
	Supplemental Benefits Business (2012 acquisition)	Great American Life		286		297	100% secured by assets in a trust.
	Other run-off reinsurance	Various		66		67	100% secured by assets in trusts.
	Total recoverables related to acquisition, disposition or runoff activities			5,711		6,000
Total reinsurance recoverables			$	6,161	$	6,478

The Company bears the risk of loss if its reinsurers and retrocessionaires do not meet or are unable to meet their reinsurance obligations to the Company. The Company reviews its reinsurance arrangements and establishes reserves against the recoverables if recovery is not considered probable.

Effects of Reinsurance

In the Company’s Consolidated Statements of Income, premiums were reported net of amounts ceded to reinsurers and Global Health Care medical costs and other benefit expenses were reported net of reinsurance recoveries in the following amounts:

	Three Months Ended				Nine Months Ended
(In millions)	September 30, 2017		September 30, 2016		September 30, 2017		September 30, 2016
Ceded premiums:
Individual life insurance and annuity business sold	$	33	$	37	$	105	$	118
Other		70		94		205		262
Total ceded premiums	$	103	$	131	$	310	$	380
Reinsurance recoveries:
Individual life insurance and annuity business sold	$	62	$	77	$	198	$	211
Other		33		8		79		209
Total reinsurance recoveries	$	95	$	85	$	277	$	420

The decrease in reinsurance recoveries for the nine months ended September 30, 2017 compared to the same period in 2016 is primarily due to the ceded GMDB business. The ceded reserves decreased during 2017 primarily due to favorable equity market conditions, while in 2016 the ceded reserves increased due to changes in the capital market and other assumptions that are used to calculate the reserves.

Effective Exit of GMDB and GMIB Business

In 2013, the Company entered into an agreement with Berkshire to effectively exit the GMDB and GMIB business via a reinsurance transaction. Berkshire reinsured 100% of the Company's future claim payments in this business, net of other reinsurance arrangements existing at that time. The Berkshire reinsurance agreement is subject to an overall limit with approximately $3.5 billion remaining as of September 30, 2017.

GMDB is accounted for as reinsurance and GMIB assets and liabilities are reported as derivatives at fair value as discussed below. GMIB assets are reported in other assets, including intangibles, and GMIB liabilities are reported in accounts payable, accrued expenses and other liabilities.

GMDB

The Company estimates the gross liability and reinsurance recoverable with an internal model based on the Company’s experience and future expectations over an extended period, consistent with the long-term nature of this product. As a result of the reinsurance transaction, reserve increases have a corresponding increase in the recorded reinsurance recoverable, provided the increased recoverable remains within the overall Berkshire limit (including the GMIB asset presented below). The ending net retained reserve covers ongoing administrative expenses, as well as minor claim exposure retained by the Company.

Activity in future policy benefit reserves for the GMDB business was as follows:

	For the period ended
	September 30,		December 31,
(In millions)	2017		2016
Balance at January 1	$	1,224	$	1,252
Add: Unpaid claims		16		18
Less: Reinsurance and other amounts recoverable		1,129		1,164
Balance at January 1, net		111		106
Add: Incurred benefits		-		4
Less: Paid benefits (recoveries)		(1)		(1)
Ending balance, net		112		111
Less: Unpaid claims		17		16
Add: Reinsurance and other amounts recoverable		1,027		1,129
Ending balance	$	1,122	$	1,224

Incurred and paid benefits are net of ceded amounts. Unpaid claims are presented before deducting ceded amounts.

The table below presents the account value, net amount at risk and number of underlying contractholders for guarantees assumed by the Company in the event of death. The net amount at risk is the amount that the Company would have to pay if all contractholders died as of the specified date. The Company will be reimbursed in full for these payments unless the Berkshire reinsurance limit is exceeded.

(Dollars in millions, excludes impact of reinsurance ceded)	September 30, 2017		December 31, 2016
Account value	$	10,797	$	10,650
Net amount at risk	$	2,187	$	2,458
Number of contractholders		265,000		285,000

GMIB

In this business, the Company reinsured contracts with issuers of GMIB products. The Company’s exposure represents the excess of a contractually guaranteed amount over the level of variable annuity account values. 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 that must occur within 30 days of a policy anniversary after the appropriate waiting period. The Company has purchased retrocessional coverage (“GMIB assets”) for these contracts.

The Company reports GMIB liabilities and assets as derivatives at fair value because the cash flows of these liabilities and assets are affected by equity markets and interest rates, but are without significant life insurance risk and are settled in lump sum payments.

As of September 30, 2017 and December 31, 2016, there were three reinsurers for GMIB as follows:

(In millions)
		September 30,		December 31,		Collateral and Other Terms
Line of Business	Reinsurer	2017		2016		at September 30, 2017
GMIB	Berkshire	$	369	$	370	100% secured by assets in a trust.
	Sun Life Assurance Company of Canada		227		227
	Liberty Re (Bermuda) Ltd.		202		202	92% secured by assets in a trust.
Total GMIB recoverables reported in other assets		$	798	$	799

Assumptions used in fair value measurement. The Company estimates the fair value of the assets and liabilities for GMIB contracts utilizing various assumptions. Assumptions that affect GMIB assets and liabilities include capital market assumptions (including market returns, interest rates and market volatilities of the underlying equity and bond mutual fund investments) and future annuitant behavior (including mortality, lapse, and annuity election rates). As certain assumptions used to estimate fair values for these contracts are largely unobservable (primarily related to future annuitant behavior), the Company classifies GMIB assets and liabilities in Level 3 in the fair value hierarchy presented in Note 9.

The only assumption expected to impact future shareholders’ net income is non-performance risk. The non-performance risk adjustment reflects a market participant’s view of nonpayment risk by adding an additional spread to the discount rate in the fair value calculation of both (a) the GMIB liabilities to be paid by the Company, and (b) the GMIB assets to be paid by the reinsurers, after considering collateral.

The Company regularly evaluates each of the assumptions used in establishing these assets and liabilities. Significant decreases in assumed lapse rates or spreads used to calculate non-performance risk of the Company, or significant increases in assumed annuity election rates or spreads used to calculate the non-performance risk of the reinsurers, would result in higher fair value measurements. A change in one of these assumptions is not necessarily accompanied by a change in another assumption.

GMIB guarantees. Future payments are not fixed and determinable under the terms of these contracts. Accordingly, the Company calculated exposure, without considering any reinsurance coverage, using the following hypothetical assumptions:

no annuitants surrendered their accounts;
all annuitants lived to elect their benefit;
all annuitants elected to receive their benefit on the next available date (2017 through 2021); and
all underlying mutual fund investment values remained at the September 30, 2017 value of $815 million with no future returns.

The Company has reinsurance coverage in place that covers the exposures on these contracts. Using these hypothetical assumptions, GMIB exposure is $615 million that is lower than the recorded liability for GMIB calculated using fair value assumptions.

- Definition

The entire disclosure pertaining to the existence, magnitude and information about insurance that has been ceded to or assumed from another insurance company, including the methodologies and assumptions used in determining recorded amounts.

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