Derivative Financial Instruments

6 Months Ended

Jun. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

The carrying amounts of derivative instruments, including derivative instruments embedded in FIA contracts, as of June 30, 2020 is as follows (in millions):


	June 30, 2020
Assets:
Derivative investments:
Call options	$	332
Futures contracts	1

Other long-term investments:
Other embedded derivatives	21


	$	354


Liabilities:
Contractholder funds:
FIA embedded derivative	$	2,952


Other liabilities:


Reinsurance related embedded derivative	35

	$	2,987

The change in fair value of derivative instruments included in the accompanying unaudited Condensed Consolidated Statements of Earnings is as follows (in millions):


	Three Months Ended
	June 30, 2020
Net investment gains (losses):
Call options	$	12
Futures contracts	2
Foreign currency forward	—
Other derivatives and embedded derivatives	1
Reinsurance related embedded derivatives	(21)
Total net investment losses	$	(6)

Benefits and other changes in policy reserves:
FIA embedded derivatives	$	100

Additional Disclosures

FIA Embedded Derivative and Call Options and Futures

We have FIA Contracts that permit the holder to elect an interest rate return or an equity index linked component, where interest credited to the contracts is linked to the performance of various equity indices, primarily the S&P 500 Index. This feature represents an embedded derivative under GAAP. The FIA embedded derivative is valued at fair value and included in the liability for contractholder funds in the accompanying unaudited Condensed Consolidated Balance Sheets with changes in fair value included as a component of Benefits and other changes in policy reserves in the unaudited Condensed Consolidated Statements of Earnings. See a description of the fair value methodology used in Note E Fair Value of Financial Instruments.

We purchase derivatives consisting of a combination of call options and futures contracts on the applicable market indices to fund the index credits due to FIA contractholders. The call options are one, two, three, and five year options purchased to match the funding requirements of the underlying policies. On the

respective anniversary dates of the index policies, the index used to compute the interest credit is reset and we purchases new one, two, three, or five year call options to fund the next index credit. We manage the cost of these purchases through the terms of our FIA contracts, which permit us to change caps, spreads or participation rates, subject to guaranteed minimums, on each contract’s anniversary date. The change in the fair value of the call options and futures contracts is generally designed to offset the portion of the change in the fair value of the FIA embedded derivative related to index performance through the current credit period. The call options and futures contracts are marked to fair value with the change in fair value included as a component of Realized gains and losses, net. The change in fair value of the call options and futures contracts includes the gains and losses recognized at the expiration of the instrument term or upon early termination and the changes in fair value of open positions.

Other market exposures are hedged periodically depending on market conditions and our risk tolerance. Our FIA hedging strategy economically hedges the equity returns and exposes us to the risk that unhedged market exposures result in divergence between changes in the fair value of the liabilities and the hedging assets. We use a variety of techniques, including direct estimation of market sensitivities, to monitor this risk daily. We intend to continue to adjust the hedging strategy as market conditions and our risk tolerance changes.

Credit Risk

We are exposed to credit loss in the event of non-performance by its counterparties on the call options and reflects assumptions regarding this non-performance risk in the fair value of the call options. The non-performance risk is the net counterparty exposure based on the fair value of the open contracts less collateral held. We maintain a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.

Information regarding our exposure to credit loss on the call options it holds as of June 30, 2020, is presented in the following table (in millions):


		June 30, 2020
Counterparty	Credit Rating (Fitch/Moody's/S&P) (1)	Notional Amount		Fair Value		Collateral		Net Credit Risk
Merrill Lynch	AA-/*/A+	$	2,873	$	34	$	—	$	34
Deutsche Bank	BBB/A3/BBB+	23		1		1		—
Morgan Stanley	*/A1/A+	2,086		23		19		4
Barclay's Bank	A+/A1/A	4,259		141		136		5
Canadian Imperial Bank of Commerce	AA/Aa2/A+	2,055		52		48		4
Wells Fargo	A+/A2/A-	2,986		74		69		5
Goldman Sachs	A/A3/BBB+	738		7		5		2
Total		$	15,020	$	332	$	278	$	54

(1) An * represents credit ratings that were not available.

Collateral Agreements

The Company is required to maintain minimum ratings as a matter of routine practice as part of its over-the-counter derivative agreements on ISDA forms. Under some ISDA agreements, the Company has agreed to maintain certain financial strength ratings. A downgrade below these levels provides the counterparty under the agreement the right to terminate the open option contracts between the parties, at which time any amounts payable by the Company or the counterparty would be dependent on the market value of the underlying option contracts. The Company's current rating doesn't allow any counterparty the right to terminate ISDA agreements. In certain transactions, the Company and the counterparty have entered into a collateral support agreement requiring either party to post collateral when the net exposures exceed pre-determined thresholds. For all counterparties, except one, this threshold is set to zero. As of June 30, 2020, counterparties posted $278 million of collateral of which $278 million is included in Cash and cash equivalents with an associated payable for this collateral included in Accounts payable and accrued liabilities on the unaudited Condensed Consolidated Balance Sheet. Accordingly, the maximum amount of loss due to credit risk that the Company

would incur if parties to the call options failed completely to perform according to the terms of the contracts was $54 million at June 30, 2020.

The Company is required to pay counterparties the effective federal funds rate each day for cash collateral posted to F&G for daily mark to market margin changes. The Company reinvests derivative cash collateral to reduce the interest cost. Cash collateral is invested in overnight investment sweep products which are included in Cash and cash equivalents in the accompanying unaudited Condensed Consolidated Balance Sheets.

The Company held 559 futures contracts at June 30, 2020. The fair value of the futures contracts represents the cumulative unsettled variation margin (open trade equity, net of cash settlements). The Company provides cash collateral to the counterparties for the initial and variation margin on the futures contracts which is included in Cash and cash equivalents in the accompanying unaudited Condensed Consolidated Balance Sheets. The amount of cash collateral held by the counterparties for such contracts was $6 million at June 30, 2020.

Reinsurance Related Embedded Derivatives

FGL Insurance entered into a reinsurance agreement with Kubera effective December 31, 2018, to cede certain MYGA and deferred annuity statutory reserve on a coinsurance funds withheld basis, net of applicable existing reinsurance. This arrangement creates an obligation for FGL Insurance to pay Kubera at a later date, which results in an embedded derivative. This embedded derivative is considered a total return swap with contractual returns that are attributable to the assets and liabilities associated with this reinsurance arrangement. The fair value of the total return swap is based on the change in fair value of the underlying assets held in the funds withheld portfolio. Investment results for the assets that support the coinsurance with funds withheld reinsurance arrangement, including gains and losses from sales, were passed directly to the reinsurer pursuant to contractual terms of the reinsurance arrangement. The reinsurance related embedded derivative is reported in Prepaid expenses and other assets if in a net gain position, or Accounts payable and accrued liabilities, if in a net loss position, on the unaudited Condensed Consolidated Balance Sheets and the related gains or losses are reported in Realized gains and losses, net on the unaudited Condensed Consolidated Statements of Earnings.