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Derivative Financial Instruments
 6 Months Ended
Jun. 30, 2011
Derivative Instruments And Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments [Text Block]

Note 8 — Derivative Financial Instruments

 

Derivative instruments associated with the Company's run-off reinsurance segment. 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”). The Company has purchased retrocessional coverage for a portion of these contracts (“GMIB assets”). Because cash flows are affected by equity markets and interest rates, but are without significant life insurance risk and are settled in lump sum payments, the Company reports these GMIB liabilities and assets as derivatives at fair value.

 

During the first quarter of 2011, the Company expanded its dynamic hedge program that substantially reduces equity market exposures associated with its GMDB business to include a portion of equity market exposures associated with its GMIB business (approximately one-quarter). The Company also implemented a dynamic hedge program to reduce the growth interest rate exposures for approximately one-third of its GMDB and one-quarter of its GMIB businesses (“GMDB and GMIB growth interest rate hedge program”). These hedge programs are dynamic because the Company will regularly rebalance the hedging instruments within established parameters as equity and interest rate exposures of these businesses change.

 

 

The Company manages these hedge programs using exchange-traded equity, foreign currency and interest rate futures contracts, and interest rate swap contracts. These contracts are generally expected to rise in value as equity markets and interest rates decline, and decline in value as equity markets and interest rates rise.

These hedge programs do not qualify for GAAP hedge accounting. Although these hedge programs effectively reduce equity market and interest rate exposures, changes in the fair values of the swap and futures contracts may not exactly offset changes in the portions of the GMDB and GMIB liabilities covered by these hedges, in part because the market does not offer contracts that exactly match the targeted exposure profile. The results of the swaps and futures contracts are included in other revenues and amounts reflecting corresponding changes in liabilities for GMDB contracts are included in benefits and expenses. Related changes in liabilities for GMIB contracts are reported in GMIB fair value (gain) loss.

 

See Notes 5 and 6 for further details regarding these businesses.

 

Derivative instruments used in the Company's investment risk management. Derivative financial instruments are also used by the Company 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 under this strategy to minimize interest rate and foreign currency risks. 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.

 

Accounting for derivative instruments. The Company applies hedge accounting when derivatives are designated, qualify and are highly effective as hedges. Effectiveness is formally assessed and documented at inception and each period throughout the life of a hedge using various quantitative methods appropriate for each hedge, including regression analysis and dollar offset. 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.

 

The Company accounts for derivative instruments as follows:

 

  • Derivatives are reported on the balance sheet at fair value with changes in fair values reported in shareholders' net income or accumulated other comprehensive income.

  • Changes in the fair value of derivatives that hedge market risk related to future cash flows and that qualify for hedge accounting are reported in a separate caption in accumulated other comprehensive income. These hedges are referred to as cash flow hedges.
  • A change in the fair value of a derivative instrument may not always equal the change in the fair value of the hedged item; this difference is referred to as hedge ineffectiveness. Where hedge accounting is used, the Company reflects hedge ineffectiveness in shareholders' net income (generally as part of realized investment gains and losses).

 

Collateral and termination features. Certain of the Company's over-the-counter derivative instruments contain provisions requiring either the Company or the counterparty to post collateral depending on the amount of the net liability position and predefined financial strength or credit rating thresholds. The collateral posting requirements vary by counterparty. The aggregate fair value of derivative instruments with such credit-risk-related contingent features where the Company was in a net liability position was $33 million at June 30, 2011 and $25 million at December 31, 2010 for which the Company was not required to post collateral with its counterparties. If the various contingent features underlying the agreements were triggered as of the balance sheet date, the Company would be required to post collateral equal to the total net liability. The Company is a party to certain other derivative instruments that contain termination provisions for which the counterparties could demand immediate payment of the total net liability position if the financial strength rating of the Company were to decline below specified levels. As of June 30, 2011 and December 31, 2010, there was no net liability position under such derivative instruments.

 

The following tables present information about the nature and accounting treatment of the Company's primary derivative financial instruments including the Company's purpose for entering into specific derivative transactions, and their locations in and effect on the financial statements as of June 30, 2011 and December 31, 2010, and for the three months and six months ended June 30, 2011 and June 30, 2010. Derivatives in the Company's separate accounts are excluded from the tables because associated gains and losses generally accrue directly to policyholders.

       

 

                   
Instrument / Volume of Activity Primary Risk Purpose Cash Flows  Accounting Policy  
                   
Derivatives Designated as Accounting Hedges - Cash Flow Hedges
Interest rate swaps — $137 million as of June 30, 2011 and $153 million as of December 31, 2010 of par value of related investments Foreign currency swaps — $134 million as of June 30, 2011 and $159 million as of December 31, 2010 of U.S. dollar equivalent par value of related investments Combination swaps (interest rate and foreign currency) — $64 million as of June 30, 2011 and December 31, 2010 of U.S. dollar equivalent par value of related investments Interest rate and foreign currency To hedge the interest and/or foreign currency cash flows of fixed maturities to match associated liabilities. Currency swaps are primarily euros, Australian dollars, Canadian dollars and British pounds for periods of up to 10 years. The Company periodically exchanges cash flows between variable and fixed interest rates and/or between two currencies for both principal and interest. Net interest cash flows are reported in operating activities.  Using cash flow hedge accounting, fair values are reported in other long-term investments or other liabilities and 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.
                           
 Fair Value Effect on the Financial Statements (In millions)
   Other Long-Term Investments Accounts Payable, Accrued Expenses and Other Liabilities  Gain (Loss) Recognized in Other Comprehensive Income (1)
   As of June 30,As of December 31, As of June 30,As of December 31,  Three Months Ended June 30, Six Months Ended June 30,
 Instrument 20112010 20112010  20112010 2011 2010 
 Interest rate swaps $ 8$ 10 $ -$ -  $ -$ 1 $ (2)  $ 2  
 Foreign currency swaps   1  6   26  20    (6)  15   (10)    19  
 Interest rate and foreign currency swaps   -  -   17  12    (2)  8   (5)    8  
 Total $ 9$ 16 $ 43$ 32  $ (8)$ 24 $ (17)  $ 29  
  (1) Other comprehensive income for foreign currency swaps excludes amounts required to adjust future policy benefits for the run-off settlement annuity business.
                            
Treasury lock Interest rate To hedge the variability of and fix at inception date, the benchmark Treasury rate component of future interest payments on debt to be issued. The Company paid the fair value of the contract at the expiration. Cash flows were reported in operating activities.  Using cash flow hedge accounting, fair values are reported in other assets or other liabilities, with changes in fair value reported in accumulated other comprehensive income and amortized to interest expense over the period of expected cash flows.
  Fair Value Effect on the Financial Statements
  During the first quarter of 2009, the remaining treasury locks matured and the Company recognized a gain of $14 million in other comprehensive income, resulting in net cumulative losses of $36 million ($23 million after-tax) recorded in other comprehensive income, that are being amortized over the period of expected cash flows. The remaining unamortized balance in other comprehensive income was $18 million after-tax as of June 30, 2011 and $19 million after-tax as of December 31, 2010.

For the three months and six months ended June 30, 2011 and 2010, the amount of gains (losses) reclassified from accumulated other comprehensive income into income was not material. No gains (losses) were recognized due to ineffectiveness and no amounts were excluded from the assessment of hedge ineffectiveness.

                 
Instrument / Volume of Activity Primary Risk Purpose Cash Flows Accounting Policy
                 
Derivatives Not Designated As Accounting Hedges
Written options (GMIB liability) — $1,089 million as of June 30, 2011 and $1,134 million as of December 31, 2010 of maximum potential undiscounted future payments as defined in Note 16 Purchased options (GMIB asset) — $599 million as of June 30, 2011 and $624 million as of December 31, 2010 of maximum potential undiscounted future receipts as defined in Note 16 Equity and interest rate The Company has written reinsurance contracts with issuers of variable annuity contracts that provide annuitants with certain guarantees related to minimum income benefits. According to the contractual terms of 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 Company purchased reinsurance contracts to reduce a portion of the risks assumed. These contracts are accounted for as written and purchased options. The Company periodically receives (pays) fees based on either contractholders' account values or deposits increased at a contractual rate. The Company will also pay (receive) cash depending on changes in account values and interest rates when contractholders first elect to receive minimum income payments. These cash flows are reported in operating activities. Fair values are reported in other liabilities (GMIB liability) and other assets (GMIB asset). Changes in fair value are reported in GMIB fair value (gain) loss.   
  Fair Value Effect on the Financial Statements (In millions)
    Other Assets, including other intangibles Accounts Payable, Accrued Expenses and Other Liabilities GMIB Fair Value (Gain) Loss
    As ofAs of As ofAs of Three Months Ended June 30, Six Months Ended June 30,
  Instrument June 30, 2011December 31, 2010 June 30, 2011December 31, 2010  2011 2010  2011 2010
  Written options (GMIB liability)      $ 917$ 903 $ 85 $ 351 $ 48 $ 347
  Purchased options (GMIB asset) $ 490$ 480        (48)   (187)   (27)   (187)
  Total $ 490$ 480 $ 917$ 903 $ 37 $ 164 $ 21 $ 160

                
Instrument / Volume of Activity Primary RiskPurpose Cash Flows   Accounting Policy
                
Derivatives Not Designated As Accounting Hedges
Futures — $862 million and $878 million of U.S. dollar equivalent notional value as of June 30, 2011 and December 31, 2010  Equity and foreign currencyTo reduce domestic and international equity market exposures resulting from changes in variable annuity account values based on underlying mutual funds for certain reinsurance contracts that guarantee minimum death benefits (GMDB) (excluding exposures due to partial surrenders) and a portion (approximately one-quarter) of these risks associated with certain reinsurance contracts that guarantee minimum income benefits (GMIB). Currency futures are euros, Japanese yen and British pounds. The Company receives (pays) cash daily in the amount of the change in fair value of the futures contracts. Cash flows are included in operating activities. Fair value changes are reported in other revenues. Amounts not yet settled from the previous day's fair value change (daily variation margin) are reported in other assets and other liabilities.
  Fair Value Effect on the Financial Statements (In millions)
         Other Revenues
         Three Months Ended June 30, Six Months Ended June 30,
         2011  2010 2011  2010
  Futures for GMDB exposures   $ (5)  $92 $ (49)  $47
  Futures for GMIB exposures      -       -    
  Total Futures      $ (5)  $92 $ (49)  $47
                      
                      
Interest rate swaps — $240 million of swap notional value as of June 30, 2011  Interest rate To reduce the exposure to changes in interest rates levels on the growth rate for certain contracts that guarantee minimum death benefits and minimum income benefits. The hedge program covers approximately one-third of the GMDB and approximately one-quarter of the GMIB growth interest exposures. For interest rate swaps, the Company periodically exchanges cash flows between variable and fixed interest rates. Cash flows are included in operating activities. For interest rate swaps, fair values are reported in other assets and other liabilities, with changes in fair value and interest income and interest expense reported in other revenues.
                     
Interest rate futures — $548 million notional value of Eurodollar futures contracts and $9 million notional value of U.S. Treasury futures contracts as of June 30, 2011        For interest rate futures, the Company receives (pays) cash daily in the amount of the change in fair value of the futures contracts. Cash flows are included in operating activities. For interest rate futures, fair value changes are reported in other revenues. Amounts not yet settled from the previous day's fair value change (daily variation margin) are reported in other assets and other liabilities.
 Fair Value Effect on the Financial Statements (In millions)
   Other assets, including other intangiblesOther Revenues
    As of Three Months Ended Six Months Ended
     June 30, 2011June 30, 2011 June 30, 2011
  Interest rate swaps $  9  $ 8  $ 12 
  Interest rate futures        (1)    - 
  Total swaps and futures   $ 7  $ 12 
                      
  Derivatives for GMDB exposures  $ 6  $ 10 
  Derivatives for GMIB exposures    1    2 
  Total swaps and futures  $ 7  $ 12 
                      

              
Instrument / Volume of Activity Primary Risk Purpose Cash Flows Accounting Policy
              
Derivatives Not Designated As Accounting Hedges
Interest rate swaps — $45 million of par value of related investments as of June 30, 2011 and December 31, 2010  Interest rate To hedge the interest cash flows of fixed maturities to match associated liabilities.  The Company periodically exchanges cash flows between variable and fixed interest rates and these cash flows are included in investing activities. Fair values are reported in other long-term investments or other liabilities, with changes in fair value reported in other realized investment gains and losses.
  Fair Value Effect on the Financial Statements (In millions)
   Other Long-Term Investments Realized Investment Gains (Losses)
    As ofAs ofThree Months Ended June 30, Six Months Ended June 30,
    June 30, 2011December 31, 2010 20112010 20112010
  Interest rate swaps $ 3$ 3$  -$ 2  $  -$ 2