Derivative Financial Instruments

6 Months Ended

Jun. 30, 2018

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Note 11 — Derivative Financial Instruments

The Company uses derivative financial instruments 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). The Company also uses derivative financial instruments to hedge the risk of changes in the net assets of certain of its foreign subsidiaries due to changes in foreign currency exchange rates, and to hedge the interest rate risk of its long-term debt. The Company has written and purchased GMIB reinsurance contracts in its run-off reinsurance business that are accounted for as freestanding derivatives and discussed further in Note 8. 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.

Accounting policy. During the first quarter of 2018, the Company early adopted ASU 2017-12 (Targeted Improvements to Accounting for Hedging Activities) with no material impact to its financial statements. The Company applies hedge accounting when derivatives are designated, qualified and highly effective as hedges. Effectiveness is formally assessed and documented at inception and each period throughout the life of a hedge using various qualitative or quantitative methods appropriate for each hedge. Under hedge accounting, the changes in fair value of the derivative and the hedged risk are generally recognized together and offset each other when reported in shareholders’ net income. Changes in the fair value of a derivative instrument may not always equal changes in the fair value of the hedged item. This is referred to as “hedge ineffectiveness” and, with the adoption of ASU 2017-12, is no longer measured and reported separately from the effective portion of the hedge. The Company excludes certain components of derivative instruments’ changes in fair value from the assessment of hedge effectiveness. With the adoption of ASU 2017-12, those excluded components are initially recorded in other comprehensive income and recognized in shareholders’ net income over the life of the derivative instrument as further discussed below. See Note 9 for further information on our policies for determining fair value. Derivative cash flows are generally reported in operating activities.

During the first quarter of 2018, the Company terminated its Fair Value Hedge of Long-Term Corporate Debt (notional value of $750 million as of December 31, 2017) with no material impact to the Company’s financial statements. The following tables provide information on the Company’s other specific applications of derivative financial instruments during the periods ended June 30, 2018 and December 31, 2017.

Economic Hedges of Benchmark Interest Rates on Expected Debt Issuances	Notional Value (in millions)
Type of instrument. Swaptions	June 30, 2018		December 31, 2017
Type of instrument. Swaptions	$	3,550	$	-

Purpose. To hedge the benchmark interest rates on forecasted coupon cash flows on debt issuances to be used primarily to finance a portion of the proposed acquisition of Express Scripts expected later in 2018.


Terms of derivative instruments. There is no upfront premium paid or received, and the instruments contain upper and lower threshold strike rates based on the benchmark interest rate. These instruments provide offsetting economic benefits when the Company receives cash at settlement as rates rise above the upper threshold, and offsetting economic losses when the Company must pay cash at settlement as rates decline below the lower threshold.


Accounting. Hedge accounting has not been designated for these instruments. The fair values of the swaption contracts are reported in other assets, including other intangibles, or accounts payable, accrued expenses, and other liabilities. Changes in fair value and settlements are reported in interest expense.

Cash Flow Hedges of Benchmark Interest Rates on Expected Debt Issuances	Notional Value (in millions)
Type of instrument. Swaptions	June 30, 2018		December 31, 2017
Type of instrument. Swaptions	$	2,050	$	-

Purpose. To hedge the benchmark interest rates on forecasted coupon cash flows on debt issuances expected later in 2018.


Terms of derivative instruments. There is no upfront premium paid or received, and the instruments contain upper and lower threshold strike rates based on the benchmark interest rate. These instruments provide offsetting economic benefits when the Company receives cash at settlement as rates rise above the upper threshold, and offsetting economic losses when the Company must pay cash at settlement as rates decline below the lower threshold. The notional value of these derivatives matches the par value of the hedged debt issuance.


Accounting. Using cash flow hedge accounting, the fair values of these instruments are reported in other assets, including other intangibles, or accounts payable, accrued expenses, and other liabilities. Changes in fair value are reported in accumulated other comprehensive income ("AOCI"). Upon issuance of the debt, any cumulative gain or loss on these contracts will begin amortizing to interest expense over the life of the hedged debt.

Fair Value Hedges of Fixed Maturity Bonds	Notional Value (in millions)
Type of instrument. Foreign currency swap contracts	June 30, 2018		December 31, 2017
Type of instrument. Foreign currency swap contracts	$	478	$	318

Purpose. To hedge the foreign exchange related changes in fair values of certain fixed maturity foreign-denominated bonds.


Terms of derivative instruments. The Company periodically exchanges cash flows between two currencies for both principal and interest. Foreign currency swaps are Euros, British pounds and Australian dollars, and have terms for periods of up to thirty years. The notional value of these derivatives matches the amortized cost of the hedged bonds.


Accounting. Using fair value hedge accounting, swap fair values are reported in other long-term investments or in accounts payable, accrued expenses and other liabilities. Changes in fair values attributable to foreign exchange risk of the swap contracts and the hedged bonds are reported in other realized investment gains and losses. The portion of the swap contracts' changes in fair value excluded from the assessment of hedge effectiveness is recorded in accumulated other comprehensive income and recognized in net investment income as swap coupon payments are accrued, offsetting the foreign denominated coupons received on the designated bonds. Prior to adopting ASU 2017-12, changes in fair value of excluded components of the swap contracts were recognized immediately in realized investment gains and losses.

Net Investment Hedge of Certain International Subsidiaries	Notional Value (in millions)
Type of instrument. Foreign currency swap contracts	June 30, 2018		December 31, 2017
Type of instrument. Foreign currency swap contracts	$	439	$	-

Purpose. During the first quarter of 2018, the Company entered into fixed-for-fixed currency swaps to reduce the risk of changes in net assets due to changes in foreign currency spot exchange rates for certain foreign subsidiaries that conduct their business principally in Euros.


Terms of derivative instruments. The Company receives fixed rate U.S. dollar coupon and principal payments, and pays fixed rate coupon and principal payments denominated in the functional currency of the hedged foreign subsidiary. The notional value of hedging instruments matches the hedged amount of subsidiary net assets. Foreign currency swaps are denominated in Euros.


Accounting. As a net investment hedge, the fair values of the swap contracts are reported in other assets, including other intangibles, or in accounts payable, accrued expenses, and other liabilities. The changes in fair values of these instruments are reported in other comprehensive income, specifically in translation of foreign currencies. The portion of the change in swap fair values relating to foreign exchange spot rates will be recognized in earnings upon deconsolidation of the hedged foreign subsidiaries. The remaining changes in swap fair value are excluded from the effectiveness assessment and recognized in other operating expenses as swap coupon payments are accrued.

Economic Hedges of a Fixed Maturity Bond Portfolio	Notional Value (in millions)
Type of instrument. Foreign currency forward contracts	June 30, 2018		December 31, 2017
Type of instrument. Foreign currency forward contracts	$	309	$	255

Purpose. To hedge the foreign exchange related changes in fair values of a U.S. dollar-denominated fixed maturity bond portfolio to reflect the local currency for the Company's foreign subsidiary in South Korea.


Terms of derivative instruments. The Company agrees to purchase South Korean won in exchange for U.S. dollars at a future date, generally within three months from the contracts' trade dates. The notional value of hedging instruments generally aligns with the fair value of the hedged bond portfolio.


Accounting. As these arrangements were not designated as accounting hedges, fair values are reported in short-term investments or accounts payable, accrued expenses, and other liabilities, and changes in fair values are reported in other realized investment gains and losses.

Gross fair values of our derivative financial instruments are presented in Note 9. As of June 30, 2018 and December 31, 2017, and for the three months and six months ended June 30, 2018 and 2017, the effects of these derivative instruments on the Consolidated Financial Statements were not material, including amounts excluded from the assessment of hedge effectiveness, as well as associated gains or losses reclassified from accumulated other comprehensive income into shareholders’ net income.

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. 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 asset or liability positions of these derivatives were not material as of June 30, 2018 or December 31, 2017.