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DERIVATIVES
 3 Months Ended
Mar. 31, 2020
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVES DERIVATIVES
The Company uses derivatives as part of its overall asset/liability risk management primarily to reduce exposures to equity market and interest rate risks. Derivative hedging strategies are designed to reduce these risks from an economic perspective and are all executed within the framework of a “Derivative Use Plan” approved by applicable states’ insurance law. Derivatives are generally not accounted for using hedge accounting, with the exception of Treasury Inflation-Protected Securities (“TIPS”), which is discussed further below. Operation of these hedging programs is based on models involving numerous estimates and assumptions, including, among others, mortality, lapse, surrender and withdrawal rates, election rates, fund performance, market volatility and interest rates. A wide range of derivative contracts are used in these hedging programs, including exchange traded equity, currency and interest rate futures contracts, total return and/or other equity swaps, interest rate swap and floor contracts, bond and bond-index total return swaps, swaptions, variance swaps and equity options, credit and foreign exchange derivatives, as well as bond and repo transactions to support the hedging. The derivative contracts are collectively managed in an effort to reduce the economic impact of unfavorable changes in guaranteed benefits’ exposures attributable to movements in capital markets. In addition, as part of its hedging strategy, the Company targets an asset level for all variable annuity products at or above a CTE98 level under most economic scenarios (Conditional Tail Expectation, or “CTE”, is a statistical measure of tail risk which quantifies the total asset requirement to sustain a loss if an event outside a given probability level has occurred. CTE98 denotes the financial resources a company would need to cover the average of the worst 2% of scenarios.)
Derivatives Utilized to Hedge Exposure to Variable Annuities with Guarantee Features
The Company has issued and continues to offer variable annuity products with GMxB features. The risk associated with the GMDB feature is that under-performance of the financial markets could result in GMDB benefits, in the event of death, being higher than what accumulated policyholders’ account balances would support. The risk associated with the GMIB feature is that under-performance of the financial markets could result in the present value of GMIB, in the event of annuitization, being higher than what accumulated policyholders’ account balances would support, taking into account the relationship between current annuity purchase rates and the GMIB guaranteed annuity purchase rates. The risk associated with products that have a GMxB derivative features liability is that under-performance of the financial markets could result in the GMxB derivative features’ benefits being higher than what accumulated policyholders’ account balances would support.
For GMxB features, the Company retains certain risks including basis, credit spread and some volatility risk and risk associated with actual versus expected actuarial assumptions for mortality, lapse and surrender, withdrawal and policyholder election rates, among other things. The derivative contracts are managed to correlate with changes in the value of the GMxB features that result from financial markets movements. A portion of exposure to realized equity volatility is hedged using equity options and variance swaps and a portion of exposure to credit risk is hedged using total return swaps on fixed income indices. Additionally, the Company is party to total return swaps for which the reference U.S. Treasury securities are contemporaneously purchased from the market and sold to the swap counterparty. As these transactions result in a transfer of control of the U.S. Treasury securities to the swap counterparty, the Company derecognizes these securities with consequent gain or loss from the sale. The Company has also purchased reinsurance contracts to mitigate the risks associated with GMDB features and the impact of potential market fluctuations on future policyholder elections of GMIB features contained in certain annuity contracts issued by the Company. The reinsurance of the GMIB features is accounted for as a derivative.
The Company has in place an economic hedge program using interest rate swaps and U.S. Treasury futures to partially protect the overall profitability of future variable annuity sales against declining interest rates.
Derivatives Utilized to Hedge Crediting Rate Exposure on SCS, SIO, MSO and IUL Products/Investment Options
The Company hedges crediting rates in the Structured Capital Strategies (“SCS”) variable annuity, Structured Investment Option in the EQUI-VEST variable annuity series (“SIO”), Market Stabilizer Option (“MSO”) in the variable life insurance products and Indexed Universal Life (“IUL”) insurance products. These products permit the contract owner to participate in the performance of an index, ETF or commodity price movement up to a cap for a set period of time. They also contain a protection feature, in which the Company will absorb, up to a certain percentage, the loss of value in an index, ETF or commodity price, which varies by product segment.
In order to support the returns associated with these features, the Company enters into derivative contracts whose payouts, in combination with fixed income investments, emulate those of the index, ETF or commodity price, subject to caps and buffers, thereby substantially reducing any exposure to market-related earnings volatility.
Derivatives Used to Hedge Equity Market Risks Associated with the General Account’s Seed Money Investments in Retail Mutual Funds
The Company’s General Account seed money investments in retail mutual funds expose us to market risk, including equity market risk which is partially hedged through equity-index futures contracts to minimize such risk.
Derivatives Used to Hedge Universal Life Products with Secondary Guarantee (“ULSG”) Policy
The Company implemented a hedge program using fixed income total return swaps to mitigate the interest rate exposure in the ULSG policy statutory liability.
Derivatives Used for General Account Investment Portfolio
The Company maintains a strategy in its General Account investment portfolio to replicate the credit exposure of fixed maturity securities otherwise permissible for investment under its investment guidelines through the sale of credit default swaps (“CDSs”). Under the terms of these swaps, the Company receives quarterly fixed premiums that, together with any initial amount paid or received at trade inception, replicate the credit spread otherwise currently obtainable by purchasing the referenced entity’s bonds of similar maturity. These credit derivatives generally have remaining terms of five years or less and are recorded at fair value with changes in fair value, including the yield component that emerges from initial amounts paid or received, reported in Net derivative gains (losses).
The Company manages its credit exposure taking into consideration both cash and derivatives based positions and selects the reference entities in its replicated credit exposures in a manner consistent with its selection of fixed maturities. In addition, the Company generally transacts the sale of CDSs in single name reference entities of investment grade credit quality and with counterparties subject to collateral posting requirements. If there is an event of default by the reference entity or other such credit event as defined under the terms of the swap contract, the Company is obligated to perform under the credit derivative and, at the counterparty’s option, either pay the referenced amount of the contract less an auction-determined recovery amount or pay the referenced amount of the contract and receive in return the defaulted or similar security of the reference entity for recovery by sale at the contract settlement auction.
To date, there have been no events of default or circumstances indicative of a deterioration in the credit quality of the named referenced entities to require or suggest that the Company will have to perform under these CDSs. The maximum potential amount of future payments the Company could be required to make under these credit derivatives is limited to the par value of the referenced securities which is the dollar or euro-equivalent of the derivative’s notional amount. The Standard North American CDS Contract (“SNAC”) or Standard European Corporate Contract (“STEC”) under which the Company executes these CDS sales transactions does not contain recourse provisions for recovery of amounts paid under the credit derivative.
The Company purchased 30-year TIPS and other sovereign bonds, both inflation linked and non-inflation linked, as General Account investments and enters into asset or cross-currency basis swaps, to result in payment of the given bond’s coupons and principal at maturity in the bond’s specified currency to the swap counterparty in return for fixed dollar amounts. These swaps, when considered in combination with the bonds, together result in a net position that is intended to replicate a dollar-denominated fixed-coupon cash bond with a yield higher than a term-equivalent U.S. Treasury bond.
The tables below present quantitative disclosures about the Company’s derivative instruments, including those embedded in other contracts required to be accounted for as derivative instruments.
Derivative Instruments by Category
 
At March 31, 2020
 
Three Months Ended March 31, 2020
 
 
 
Fair Value
 
 
 Notional Amount
 
 Derivative Assets
 
 Derivative Liabilities
 
Net Derivative Gains (Losses) (2)
 
(in millions)
Derivative instruments:
 
 
 
 
 
 
 
Freestanding derivatives (1):
 
 
 
 
 
 
 
Equity contracts:
 
 
 
 
 
 
 
Futures
$
6,317

 
$
2

 
$
5

 
$
220

Swaps
12,947

 
585

 
124

 
3,778

Options
30,050

 
2,547

 
3,086

 
(3,851
)
Interest rate contracts:
 
 
 
 
 
 
 
Swaps
22,896

 
2,475

 
343

 
3,578

Futures
26,713

 
—

 
—

 
1,988

Swaptions
—

 
—

 
—

 
9

Credit contracts:
 
 
 
 
 
 
 
Credit default swaps
1,507

 
26

 
22

 
(1
)
Other freestanding contracts:
 
 
 
 
 
 
 
Foreign currency contracts
430

 
9

 
8

 
(2
)
Margin
—

 
107

 
171

 
—

Collateral
—

 
29

 
3,757

 
—

 
 
 
 
 
 
 
 
Embedded derivatives:
 
 
 
 
 
 
 
GMIB reinsurance contracts (3)
—

 
2,823

 
—

 
726

GMxB derivative features liability (4)
—

 
—

 
9,727

 
(1,198
)
SCS, SIO, MSO and IUL indexed features (5)
—

 
—

 
(940
)
 
4,154

Total derivative instruments
$
100,860

 
$
8,603

 
$
16,303

 


 
 
 
 
 
 
 
 
Net derivative gains (losses)
 
 
 
 
 
 
$
9,401

______________
(1)
Reported in Other invested assets in the consolidated balance sheets.
(2)
Reported in Net derivative gains (losses) in the consolidated statements of income (loss).
(3)
Reported in GMIB reinsurance contract asset in the consolidated balance sheets.
(4)
Reported in Future policy benefits and other policyholders’ liabilities in the consolidated balance sheets.
(5)
Reported in Policyholders’ account balances in the consolidated balance sheets.
Derivative Instruments by Category
 
At December 31, 2019
 
Three Months Ended March 31, 2019
 
 
 
Fair Value
 
 
 Notional Amount
 
Derivative Assets
 
Derivative
Liabilities
 
Net Derivative
Gains (Losses) (2)
 
(in millions)
Derivative instruments:
 
 
 
 
 
 
 
Freestanding derivatives (1):
 
 
 
 
 
 
 
Equity contracts:
 
 
 
 
 
 
 
Futures
$
4,257

 
$
1

 
$
1

 
$
(762
)
Swaps
17,156

 
9

 
281

 
(985
)
Options
47,861

 
5,098

 
1,752

 
1,111

Interest rate contracts:
 
 
 
 
 
 
 
Swaps
23,793

 
468

 
526

 
648

Futures
20,901

 
—

 
—

 
56

Swaptions
3,201

 
16

 
—

 
—

Credit contracts:
 
 
 
 
 
 
 
Credit default swaps
1,400

 
21

 
6

 
7

Other freestanding contracts:
 
 
 
 
 
 
 
Foreign currency contracts
559

 
12

 
9

 
10

Margin
—

 
155

 
—

 
—

Collateral
—

 
74

 
3,016

 
—

 
 
 
 
 
 
 
 
Embedded derivatives:

 
 
 
 
 
 
 
GMIB reinsurance contracts (3)
 
 
2,139

 
—

 
18

GMxB derivative features liability (4)
—

 
—

 
8,432

 
(408
)
SCS, SIO, MSO and IUL indexed features (5)
—

 
—

 
3,268

 
(1,325
)
Total derivative instruments
$
119,128

 
$
7,993

 
$
17,291

 


 
 
 
 
 
 
 
 
Net derivative gains (losses)
 
 
 
 
 
 
$
(1,630
)
______________
(1)
Reported in Other invested assets in the consolidated balance sheets.
(2)
Reported in Net derivative gains (losses) in the consolidated statements of income (loss).
(3)
Reported in GMIB reinsurance contract asset in the consolidated balance sheets.
(4)
Reported in Future policy benefits and other policyholders’ liabilities in the consolidated balance sheets.
(5)
Reported in Policyholders’ account balances in the consolidated balance sheets.
Equity-Based and Treasury Futures Contracts Margin
All outstanding equity-based and treasury futures contracts at March 31, 2020 and December 31, 2019 are exchange-traded and net settled daily in cash. At March 31, 2020 and December 31, 2019, respectively, the Company had open exchange-traded futures positions on: (i) the S&P 500, Russell 2000 and Emerging Market indices, having initial margin requirements of $466 million and $252 million, (ii) the 2-year, 5-year and 10-year U.S. Treasury Notes on U.S. Treasury bonds and ultra-long bonds, having initial margin requirements of $651 million and $166 million, and (iii) the Euro Stoxx, FTSE 100, Topix, ASX 200 and European, Australasia, and Far East (“EAFE”) indices as well as corresponding currency futures on the Euro/U.S. dollar, Pound/U.S. dollar, Australian dollar/U.S. dollar, and Yen/U.S. dollar, having initial margin requirements of $159 million and $60 million.
Collateral Arrangements
The Company generally has executed a Credit Support Annex (“CSA”) under the International Swaps and Derivatives Association Master Agreement (“ISDA Master Agreement”) it maintains with each of its over-the-counter (“OTC”) derivative counterparties that requires both posting and accepting collateral either in the form of cash or high-quality securities, such as U.S. Treasury securities, U.S. government and government agency securities and investment grade corporate bonds. The Company nets the fair value of all derivative financial instruments with counterparties for which
an ISDA Master Agreement and related CSA have been executed. At March 31, 2020 and December 31, 2019, respectively, the Company held $3.8 billion and $3.0 billion in cash and securities collateral delivered by trade counterparties, representing the fair value of the related derivative agreements. The unrestricted cash collateral is reported in Other invested assets. The Company posted collateral of $29 million and $74 million at March 31, 2020 and December 31, 2019, respectively, in the normal operation of its collateral arrangements.
The following table presents information about the Company’s offsetting of financial assets and liabilities and derivative instruments at March 31, 2020:
Offsetting of Financial Assets and Liabilities and Derivative Instruments
At March 31, 2020
 
Gross Amount Recognized
 
Gross Amount Offset in the Balance Sheets
 
Net Amount Presented in the Balance Sheets
 
Gross Amount not Offset in the Balance Sheets (3)
 
Net Amount
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
Derivative assets (1)
$
5,779

 
$
5,522

 
$
257

 
$
(162
)
 
$
95

Other financial assets
1,855

 
—

 
1,855

 
—

 
1,855

Other invested assets
$
7,634

 
$
5,522

 
$
2,112

 
$
(162
)
 
$
1,950

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities (2)
$
7,354

 
$
5,522

 
$
1,832

 
$
—

 
$
1,832

Other financial liabilities
3,884

 
—

 
3,884

 
—

 
3,884

Other liabilities
$
11,238

 
$
5,522

 
$
5,716

 
$
—

 
$
5,716

______________
(1)
Excludes Investment Management and Research segment’s derivative assets of consolidated VIEs/VOEs.
(2)
Excludes Investment Management and Research segment’s derivative liabilities of consolidated VIEs/VOEs.
(3)
Primarily financial instrument sent (held).
The following table presents information about the Company’s offsetting of financial assets and liabilities and derivative instruments at December 31, 2019:
Offsetting of Financial Assets and Liabilities and Derivative Instruments
At December 31, 2019
 
Gross Amount Recognized
 
Gross Amount Offset in the Balance Sheets
 
Net Amount Presented in the Balance Sheets
 
Gross Amount not Offset in the Balance Sheets (3)
 
Net Amount
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
Derivative assets (1)
$
5,852

 
$
5,466

 
$
386

 
$
(77
)
 
$
309

Other financial instruments
2,394

 
—

 
2,394

 
—

 
2,394

Other invested assets
$
8,246

 
$
5,466

 
$
2,780

 
$
(77
)
 
$
2,703

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities (2)
$
5,512

 
$
5,466

 
$
46

 
$
—

 
$
46

Other financial liabilities
3,924

 
—

 
3,924

 
—

 
3,924

Other liabilities
$
9,436

 
$
5,466

 
$
3,970

 
$
—

 
$
3,970

______________
(1)
Excludes Investment Management and Research segment’s derivative assets of consolidated VIEs/VOEs.
(2)
Excludes Investment Management and Research segment’s derivative liabilities of consolidated VIEs/VOEs.
(3)     Primarily financial instrument sent (held).