4. DERIVATIVE INSTRUMENTS

Types of Derivative Instruments and Derivative Strategies

The Company utilizes various derivative instruments and strategies to manage its risk. Commonly used derivative instruments include but are not necessarily limited to:


•	Interest rate contracts: futures, swaps, forwards, options, swaptions, caps and floors

•Equity contracts: futures, options and total return swaps

•Foreign exchange contracts: futures, options, forwards and swaps

•Credit contracts: single and index reference credit default swaps

•Other contracts: embedded derivatives

For detailed information on these contracts and the related strategies, see Note 11 to the Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Primary Risks Managed by Derivatives

The table below provides a summary of the gross notional amount and fair value of derivatives contracts by the primary underlying risks, excluding embedded derivatives and associated reinsurance recoverables. Many derivative instruments contain multiple underlying risks. The fair value amounts below represent the gross fair value of derivative contracts prior to taking into account the netting effects of master netting agreements, cash collateral and NPR.



	September 30, 2018							December 31, 2017
Primary Underlying Risk/Instrument Type			Gross Fair Value							Gross Fair Value
Primary Underlying Risk/Instrument Type	Notional		Assets		Liabilities			Notional		Assets		Liabilities
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Currency/Interest Rate
Foreign Currency Swaps	$	748,787	$	18,033	$	(38,666	)	$	677,257	$	13,348	$	(47,209	)
Total Qualifying Hedges	$	748,787	$	18,033	$	(38,666	)	$	677,257	$	13,348	$	(47,209	)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate
Interest Rate Futures	$	903,500	$	272	$	(2,508	)	$	1,964,000	$	8,296	$	0
Interest Rate Swaps	80,605,225		3,378,320		(2,578,179		)	87,939,425		4,374,658		(1,065,549		)
Interest Rate Options	19,050,000		157,095		(326,477		)	15,775,000		175,156		(160,181		)
Interest Rate Forwards	1,626,323		14		(32,402		)	975,929		19,870		(2		)
Foreign Currency
Foreign Currency Forwards	15,281		104		0			12,455		1		(319		)
Currency/Interest Rate
Foreign Currency Swaps	157,819		7,414		(6,740		)	151,400		7,779		(7,488		)
Equity
Equity Futures	253,208		78		0			672,055		2,442		0
Total Return Swaps	14,200,030		17,006		(270,367		)	13,841,333		8,517		(341,700		)
Equity Options	32,801,821		630,109		(569,941		)	31,702,334		460,597		(318,955		)
Total Non-Qualifying Hedges	$	149,613,207	$	4,190,412	$	(3,786,614	)	$	153,033,931	$	5,057,316	$	(1,894,194	)
Total Derivatives(1)	$	150,361,994	$	4,208,445	$	(3,825,280	)	$	153,711,188	$	5,070,664	$	(1,941,403	)


(1)	Excludes embedded derivatives and associated reinsurance recoverables which contain multiple underlying risks.

The fair value of the embedded derivatives, included in "Future policy benefits," was a net liability of $4,995 million and $8,152 million as of September 30, 2018 and December 31, 2017, respectively. The fair value of the related reinsurance recoverables to Prudential Insurance was a net asset of $156 million and $232 million as of September 30, 2018 and December 31, 2017, respectively, included in "Reinsurance recoverables". See Note 7 for additional information on these reinsurance agreements.

The fair value of the embedded derivatives pertaining to the variable annuity products with a market value adjustment option assumed from Pruco Life as part of the Variable Annuities Recapture, included in "Reinsurance recoverables" or "Reinsurance payables," was a net asset of $3 million and $12 million as of September 30, 2018 and December 31, 2017, respectively.

The fair value of the embedded derivatives, included in "Policyholders' account balances," was a net liability of $34 million as of September 30, 2018 with no related reinsurance recoverables.

Offsetting Assets and Liabilities

The following table presents recognized derivative instruments (excluding embedded derivatives and associated reinsurance recoverables), and repurchase and reverse repurchase agreements that are offset in the Unaudited Interim Consolidated Statements of Financial Position, and/or are subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in the Unaudited Interim Consolidated Statements of Financial Position.



	September 30, 2018
	Gross Amounts of Recognized Financial Instruments		Gross Amounts Offset in the Consolidated Statements of Financial Position			Net Amounts Presented in the Consolidated Statements of Financial Position		Financial Instruments/ Collateral(1)			Net Amount
	(in thousands)
Offsetting of Financial Assets:
Derivatives(1)	$	4,208,445	$	(4,208,445	)	$	0	$	0		$	0
Securities purchased under agreements to resell	327,000		0			327,000		(327,000		)	0
Total Assets	$	4,535,445	$	(4,208,445	)	$	327,000	$	(327,000	)	$	0
Offsetting of Financial Liabilities:
Derivatives(1)	$	3,825,280	$	(3,818,167	)	$	7,113	$	(3,781	)	$	3,332
Securities sold under agreements to repurchase	0		0			0		0			0
Total Liabilities	$	3,825,280	$	(3,818,167	)	$	7,113	$	(3,781	)	$	3,332



	December 31, 2017
	Gross Amounts of Recognized Financial Instruments		Gross Amounts Offset in the Statements of Financial Position			Net Amounts Presented in the Statements of Financial Position		Financial Instruments/ Collateral(1)		Net Amount
	(in thousands)
Offsetting of Financial Assets:
Derivatives(1)	$	5,070,517	$	(4,919,486	)	$	151,031	$	0	$	151,031
Securities purchased under agreements to resell	0		0			0		0		0
Total Assets	$	5,070,517	$	(4,919,486	)	$	151,031	$	0	$	151,031
Offsetting of Financial Liabilities:
Derivatives(1)	$	1,941,403	$	(1,941,403	)	$	0	$	0	$	0
Securities sold under agreements to repurchase	0		0			0		0		0
Total Liabilities	$	1,941,403	$	(1,941,403	)	$	0	$	0	$	0


(1)	Amounts exclude the excess of collateral received/pledged from/to the counterparty.

For information regarding the rights of offset associated with the derivative assets and liabilities in the table above see “Credit Risk” below and Note 9. For securities purchased under agreements to resell and securities sold under agreements to repurchase, the Company monitors the value of the securities and maintains collateral, as appropriate, to protect against credit exposure. Where the Company has entered into repurchase and resale agreements with the same counterparty, in the event of default, the Company would generally be permitted to exercise rights of offset. For additional information on the Company’s accounting policy for securities repurchase and resale agreements, see Note 2 to the Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Cash Flow Hedges

The primary derivative instruments used by the Company in its cash flow hedge accounting relationships are currency swaps. These instruments are only designated for hedge accounting in instances where the appropriate criteria are met. The Company does not use futures, options, credit, equity or embedded derivatives in any of its cash flow hedge accounting relationships.

The following tables provide the financial statement classification and impact of derivatives used in qualifying and non-qualifying hedge relationships, excluding the offset of the hedged item in an effective hedge relationship.



	Three Months Ended September 30, 2018
	Realized Investment Gains (Losses)			Net Investment Income		Other Income		AOCI(1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	2,141	$	2,484	$	257
Total cash flow hedges	0			2,141		2,484		257
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(772,889		)	0		0		0
Currency	213			0		0		0
Currency/Interest Rate	1,224			0		33		0
Equity	(640,413		)	0		0		0
Embedded Derivatives	1,487,675			0		0		0
Total non-qualifying hedges	75,810			0		33		0
Total	$	75,810		$	2,141	$	2,517	$	257



	Nine Months Ended September 30, 2018
	Realized Investment Gains (Losses)			Net Investment Income		Other Income		AOCI(1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	5,841	$	8,973	$	1,984
Total cash flow hedges	0			5,841		8,973		1,984
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(2,360,922		)	0		0		0
Currency	537			0		0		0
Currency/Interest Rate	5,279			0		62		0
Equity	(879,866		)	0		0		0
Embedded Derivatives	3,937,437			0		0		0
Total non-qualifying hedges	702,465			0		62		0
Total	$	702,465		$	5,841	$	9,035	$	1,984



	Three Months Ended September 30, 2017
	Realized Investment Gains (Losses)			Net Investment Income		Other Income			AOCI(1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	1,678	$	(3,496	)	$	(12,020	)
Total cash flow hedges	0			1,678		(3,496		)	(12,020		)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	52,535			0		0			0
Currency	(230		)	0		0			0
Currency/Interest Rate	(11,358		)	0		(314		)	0
Equity	(453,516		)	0		0			0
Embedded Derivatives	1,585,732			0		0			0
Total non-qualifying hedges	1,173,163			0		(314		)	0
Total	$	1,173,163		$	1,678	$	(3,810	)	$	(12,020	)



	Nine Months Ended September 30, 2017
	Realized Investment Gains (Losses)			Net Investment Income		Other Income			AOCI(1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	4,523	$	(9,308	)	$	(27,143	)
Total cash flow hedges	0			4,523		(9,308		)	(27,143		)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	618,534			0		0			0
Currency	(307		)	0		0			0
Currency/Interest Rate	(22,712		)	0		(592		)	0
Equity	(1,468,601		)	0		0			0
Embedded Derivatives	550,630			0		0			0
Total non-qualifying hedges	(322,456		)	0		(592		)	0
Total	$	(322,456	)	$	4,523	$	(9,900	)	$	(27,143	)


(1)	Amounts deferred in AOCI.

For the nine months ended September 30, 2018 and 2017, the ineffective portion of derivatives accounted for using hedge accounting was de minimis to the Company’s results of operations. Also, there were no material amounts reclassified into earnings relating to instances in which the Company discontinued cash flow hedge accounting because the forecasted transaction did not occur by the anticipated date or within the additional time period permitted by the authoritative guidance for the accounting for derivatives and hedging.

Presented below is a rollforward of current period cash flow hedges in AOCI before taxes:



	(in thousands)
Balance, December 31, 2017	$	(25,851	)
Net deferred gains (losses) on cash flow hedges from January 1 to September 30, 2018	15,834
Amount reclassified into current period earnings	(13,850		)
Balance, September 30, 2018	$	(23,867	)

The changes in fair value of cash flow hedges are deferred in AOCI and are included in "Net unrealized investment gains (losses)" in the Unaudited Interim Consolidated Statements of Operations and Comprehensive Income (Loss); these amounts are then reclassified to earnings when the hedged item affects earnings. Using September 30, 2018 values, it is estimated that a pre-tax gain of $9 million will be reclassified from AOCI to earnings during the subsequent twelve months ending September 30, 2019, offset by amounts pertaining to the hedged items.

The exposures the Company is hedging with these qualifying cash flow hedges include the variability of the payment or receipt of interest or foreign currency amounts on existing financial instruments.

Credit Derivatives

The Company has no exposure from credit derivative positions where it has written or purchased credit protection as of September 30, 2018 and December 31, 2017.

Credit Risk

The Company is exposed to credit-related losses in the event of non-performance by counterparty to financial derivative transactions with a positive fair value. The Company manages credit risk by entering into derivative transactions with its affiliate, Prudential Global Funding, LLC (“PGF”), related to its over-the-counter ("OTC") derivatives. PGF, in turn, manages its credit risk by: (i) entering into derivative transactions with highly rated major international financial institutions and other creditworthy counterparties governed by master netting agreement, as applicable; (ii) trading through central clearing and OTC parties; (iii) obtaining collateral, such as cash and securities, when appropriate; and (iv) setting limits on single party credit exposures which are subject to periodic management review.

Substantially all of the Company’s derivative agreements have zero thresholds which require daily full collateralization by the party in a liability position.