DERIVATIVE INSTRUMENTS

Types of Derivative Instruments and Derivative Strategies

Interest Rate Contracts

Interest rate swaps, options and futures are used by the Company to reduce risks from changes in interest rates, manage interest rate exposures arising from mismatches between assets and liabilities and to hedge against changes in their values it owns or anticipates acquiring or selling.

Swaps may be attributed to specific assets or liabilities or to a portfolio of assets or liabilities. Under interest rate swaps, the Company agrees with counterparties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed upon notional principal amount.

The Company also uses interest rate swaptions, caps and floors to manage interest rate risk. A swaption is an option to enter into a swap with a forward starting effective date. The Company pays a premium for purchased swaptions and receives a premium for written swaptions. In an interest rate cap, the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price. Similarly, in an interest rate floor, the buyer receives payments at the end of each period in which the interest rate is below the agreed strike price. Swaptions, caps and floors are included in interest rate options.

In standardized exchange-traded interest rate futures transactions, the Company purchases or sells a specified number of contracts, the values of which are determined by the daily market values of underlying referenced investments. The Company enters into exchange-traded futures with regulated futures commission's merchants who are members of a trading exchange.

Equity Contracts

Equity options, total return swaps, and futures are used by the Company to manage its exposure to the equity markets which impacts the value of assets and liabilities it owns or anticipates acquiring or selling.

Equity index options are contracts which will settle in cash based on differentials in the underlying indices at the time of exercise and the strike price. The Company uses combinations of purchases and sales of equity index options to hedge the effects of adverse changes in equity indices within a predetermined range.

Total return swaps are contracts whereby the Company agrees with counterparties to exchange, at specified intervals, the difference between the return on an asset (or market index) and London Inter-Bank Offered Rate ("LIBOR") plus an associated funding spread based on a notional amount. The Company generally uses total return swaps to hedge the effect of adverse changes in equity indices.

In standardized exchange-traded equity futures transactions, the Company purchases or sells a specified number of contracts, the values of which are determined by the daily market values underlying referenced equity indices. The Company enters into exchange-traded futures with regulated futures commission's merchants who are members of a trading exchange.

Foreign Exchange Contracts

Currency derivatives, including currency swaps and forwards, are used by the Company to reduce risks from changes in currency exchange rates with respect to investments denominated in foreign currencies that the Company either holds or intends to acquire or sell.

Under currency forwards, the Company agrees with counterparties to deliver a specified amount of an identified currency at a specified future date. Typically, the price is agreed upon at the time of the contract and payment for such a contract is made at the specified future date. The Company executes forward sales of the hedged currency in exchange for U.S. dollars at a specified exchange rate. The maturities of these forwards correspond with the future periods in which the non-U.S. dollar-denominated earnings are expected to be generated.

Under currency swaps, the Company agrees with counterparties to exchange, at specified intervals, the difference between one currency and another at an exchange rate and calculated by reference to an agreed principal amount. Generally, the principal amount of each currency is exchanged at the beginning and termination of the currency swap by each party.

Credit Contracts

The Company writes credit protection to gain exposure similar to investment in public fixed maturity cash instruments. With these credit derivatives the Company sells credit protection on a single name reference, or certain index reference, and in return receives a quarterly premium. This premium or credit spread generally corresponds to the difference between the yield on the referenced names (or an index's referenced names) public fixed maturity cash instruments and swap rates, at the time the agreement is executed. If there is an event of default by the referenced name or one of the referenced names in the index, as defined by the agreement, then the Company is obligated to pay the referenced amount of the contract to the counterparty and receive in return the referenced defaulted security or similar security or (in the case of a credit default index) pay the referenced amount less the auction recovery rate.

In addition to selling credit protection, the Company purchases credit protection using credit derivatives in order to hedge specific credit exposures in the Company’s investment portfolio.

Embedded Derivatives

The Company sells certain products (for example, variable annuities) which may include guaranteed benefit features that are accounted for as embedded derivatives. Related to these embedded derivatives, the Company had previously entered into reinsurance agreements with Pruco Re and Prudential Insurance through March 31, 2016; effective April 1, 2016, the Company recaptured these reinsurances. Also, effective April 1, 2016, the Company assumed variable annuities living benefit guarantees from Pruco Life, excluding PLNJ business. See Note 1 for additional information on the change to the reinsurance agreements.

Additionally, the Company reinsured the majority of its New York business to an affiliate, Prudential Insurance, as a result of surrendering its New York license, effective December 31, 2015. See Note 1 for additional information on these reinsurance agreements.

These embedded derivatives and reinsurance agreements, also accounted for as derivatives, are carried at fair value and marked to market through “Realized investment gains (losses), net” based on the change in value of the underlying contractual guarantees, which are determined using valuation models, as described in Note 5.

Primary Risks Managed by Derivatives

The table below provides a summary of the gross notional amount and fair value of derivative 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.



	December 31, 2018							December 31, 2017
			Gross Fair Value							Gross Fair Value
Primary Underlying	Notional		Assets		Liabilities			Notional		Assets		Liabilities

	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Currency/Interest Rate
Foreign Currency Swaps	$	768,075	$	33,348	$	(21,794	)	$	677,257	$	13,348	$	(47,209	)
Total Qualifying Hedges	$	768,075	$	33,348	$	(21,794	)	$	677,257	$	13,348	$	(47,209	)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate
Interest Rate Futures	$	908,100	$	4,380	$	(664	)	$	1,964,000	$	8,296	$	0
Interest Rate Swaps	82,172,825		3,344,033		(1,395,270		)	87,939,425		4,374,658		(1,065,549		)
Interest Rate Options	19,255,000		139,765		(245,523		)	15,775,000		175,156		(160,181		)
Interest Rate Forwards	1,713,947		56,562		(1,976		)	975,929		19,870		(2		)
Foreign Currency
Foreign Currency Forwards	19,467		287		(27		)	12,455		1		(319		)
Currency/Interest Rate
Foreign Currency Swaps	231,245		11,659		(2,850		)	151,400		7,779		(7,488		)
Equity
Equity Futures	860,718		0		(6,629		)	672,055		2,442		0
Total Return Swaps	14,456,836		986,130		(53,235		)	13,841,333		8,517		(341,700		)
Equity Options	26,861,807		271,630		(412,821		)	31,702,334		460,597		(318,955		)
Total Non-Qualifying Hedges	$	146,479,945	$	4,814,446	$	(2,118,995	)	$	153,033,931	$	5,057,316	$	(1,894,194	)
Total Derivatives (1)	$	147,248,020	$	4,847,794	$	(2,140,789	)	$	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 $8,332 million and $8,152 million as of December 31, 2018 and 2017, respectively. The fair value of the related reinsurance recoverables to Prudential Insurance was an asset of $234 million and $232 million as of December 31, 2018 and 2017, respectively, included in "Reinsurance recoverables". See Note 10 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 $6 million and $12 million as of December 31, 2018 and 2017, respectively.

The fair value of the embedded derivatives, included in "Policyholders' account balances", was a net liability of $42 million as of December 31, 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 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 Statements of Financial Position.



	December 31, 2018
	Gross Amounts of Recognized Financial Instruments		Gross Amounts Offset in the Statement of Financial Position			Net Amounts Presented in the Statement of Financial Position		Financial Instruments/ Collateral(1)			Net Amount

	(in thousands)
Offsetting of Financial Assets:
Derivatives(1)	$	4,847,794	$	(4,804,816	)	$	42,978	$	0		$	42,978
Securities purchased under agreements to resell	675,000		0			675,000		(675,000		)	0
Total Assets	$	5,522,794	$	(4,804,816	)	$	717,978	$	(675,000	)	$	42,978
Offsetting of Financial Liabilities:
Derivatives(1)	$	2,140,789	$	(2,134,160	)	$	6,629	$	(6,629	)	$	0
Securities sold under agreements to repurchase	0		0			0		0			0
Total Liabilities	$	2,140,789	$	(2,134,160	)	$	6,629	$	(6,629	)	$	0

	December 31, 2017
	Gross Amounts of Recognized Financial Instruments		Gross Amounts Offset in the Statement of Financial Position			Net Amounts Presented in the Statement 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 14. 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.

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.



	Year Ended December 31, 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		$	8,285	$	13,321		$	22,002
Total cash flow hedges	0			8,285		13,321			22,002
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(1,021,687		)	0		0			0
Currency	1,022			0		0			0
Currency/Interest Rate	21,043			0		91			0
Credit	0			0		0			0
Equity	995,958			0		0			0
Embedded Derivatives	971,167			0		0			0
Total non-qualifying hedges	967,503			0		91			0
Total	$	967,503		$	8,285	$	13,412		$	22,002

	Year Ended December 31, 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		$	6,152	$	(11,043	)	$	(37,596	)
Total cash flow hedges	0			6,152		(11,043		)	(37,596		)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	550,797			0		0			0
Currency	(454		)	0		0			0
Currency/Interest Rate	(30,173		)	0		(183		)	0
Credit	0			0		0			0
Equity	(2,000,297		)	0		0			0
Embedded Derivatives	678,698			0		0			0
Total non-qualifying hedges	(801,429		)	0		(183		)	0
Total	$	(801,429	)	$	6,152	$	(11,226	)	$	(37,596	)



	Year Ended December 31, 2016
	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		$	3,006	$	9,648	$	(3,102	)
Total cash flow hedges	0			3,006		9,648		(3,102		)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(2,219,894		)	0		0		0
Currency	361			0		0		0
Currency/Interest Rate	11,642			0		516		0
Credit	0			0		0		0
Equity	(1,755,946		)	0		0		0
Embedded Derivatives	437,323			0		0		0
Total non-qualifying hedges	(3,526,514		)	0		516		0
Total	$	(3,526,514	)	$	3,006	$	10,164	$	(3,102	)


(1)	Amounts deferred in AOCI.

For the years ended December 31, 2018, 2017 and 2016, 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, 2015	$	14,847
Net deferred gains (losses) on cash flow hedges from January 1 to December 31, 2016	9,698
Amount reclassified into current period earnings	(12,800		)
Balance, December 31, 2016	11,745
Net deferred gains (losses) on cash flow hedges from January 1 to December 31, 2017	(39,434		)
Amount reclassified into current period earnings	1,838
Balance, December 31, 2017	(25,851		)
Net deferred gains (losses) on cash flow hedges from January 1 to December 31, 2018	42,763
Amount reclassified into current period earnings	(20,761		)
Balance, December 31, 2018	$	(3,849	)

The changes in fair value of cash flow hedges are deferred in AOCI and are included in “Net unrealized investment gains (losses)” in the Statements of Operations and Comprehensive Income; these amounts are then reclassified to earnings when the hedged item affects earnings. Using December 31, 2018 values, it is estimated that a pre-tax gain of approximately $10 million will be reclassified from AOCI to earnings during the subsequent twelve months ending December 31, 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 December 31, 2018 and 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 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.