Financial Instruments

12 Months Ended

Dec. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Financial Instruments:

Overview

PMI operates in markets outside of the United States of America, with manufacturing and sales facilities in various locations around the world. PMI utilizes certain financial instruments to manage foreign currency and interest rate exposure. Derivative financial instruments are used by PMI principally to reduce exposures to market risks resulting from fluctuations in foreign currency exchange and interest rates by creating offsetting exposures. PMI is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. PMI formally documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction will occur. If it were deemed probable that the forecasted transaction would not occur, the gain or loss would be recognized in earnings.

PMI uses deliverable and non-deliverable forward foreign exchange contracts, foreign currency swaps and foreign currency options, collectively referred to as foreign exchange contracts ("foreign exchange contracts"), and interest rate contracts to mitigate its exposure to changes in exchange and interest rates from third-party and intercompany actual and forecasted transactions. Both foreign exchange contracts and interest rate contracts are collectively referred to as derivative contracts ("derivative contracts"). The primary currencies to which PMI is exposed include the Euro, Indonesian rupiah, Japanese yen, Mexican peso, Philippine peso, Russian ruble and Swiss franc. At December 31, 2019 and 2018, PMI had contracts with aggregate notional amounts of $24.1 billion and $27.4 billion, respectively. Of the $24.1 billion aggregate notional amount at December 31, 2019, $2.8 billion related to cash flow hedges, $9.9 billion related to hedges of net investments in foreign operations and $11.4 billion related to other derivatives that primarily offset currency exposures on intercompany financing. Of the $27.4 billion aggregate notional amount at December 31, 2018, $3.2 billion related to cash flow hedges, $10.1 billion related to hedges of net investments in foreign operations and $14.1 billion related to other derivatives that primarily offset currency exposures on intercompany financing.

The fair value of PMI’s derivative exchange contracts included in the consolidated balance sheet as of December 31, 2019 and 2018, were as follows:



	Derivative Assets					Derivative Liabilities
		Fair Value					Fair Value
(in millions)	Balance Sheet Classification	2019		2018		Balance Sheet Classification	2019		2018
Derivative contracts designated as hedging instruments	Other current assets	$	319	$	54	Other accrued liabilities	$	23	$	47
	Other assets	21		99		Income taxes and other liabilities	301		525
Derivative contracts not designated as hedging instruments	Other current assets	50		67		Other accrued liabilities	70		46
	Other assets	—		—		Income taxes and other liabilities	25		13
Total derivatives		$	390	$	220		$	419	$	631

For the years ended December 31, 2019, 2018 and 2017, PMI's cash flow and net investment hedging instruments impacted the consolidated statements of earnings and comprehensive earnings as follows:



(pre-tax, in millions)	For the Year Ended December 31,
	Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives								Statement of Earnings Classification of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings
	2019			2018		2017				2019			2018			2017
Derivatives in Cash Flow Hedging Relationship
Derivative contracts	$	(20	)	$	28	$	(52	)
									Net revenues	$	22		$	18		$	60
									Cost of sales	1			—			1
									Marketing, administration and research costs	2			6			(7		)
									Interest expense, net	(8		)	(1		)	(41		)
Derivatives in Net Investment Hedging Relationship
Derivative contracts	369			324		(1,644		)
Total	$	349		$	352	$	(1,696	)		$	17		$	23		$	13

Cash Flow Hedges

PMI has entered into derivative contracts to hedge the foreign currency exchange and interest rate risks related to certain forecasted transactions. Gains and losses associated with qualifying cash flow hedge contracts are deferred as components of accumulated other comprehensive losses until the underlying hedged transactions are reported in PMI’s consolidated statements of earnings. As of December 31, 2019, PMI has hedged forecasted transactions for periods not exceeding the next twelve months, with the exception of one derivative contract that expires in May 2024. The impact of these hedges is primarily included in operating cash flows on PMI’s consolidated statements of cash flows.

Hedges of Net Investments in Foreign Operations

PMI designates certain foreign currency denominated debt and derivative contracts as net investment hedges, primarily of its Euro net assets. For the years ended December 31, 2019, 2018 and 2017, these hedges of net investments resulted in gains (losses), net of income taxes, of $470 million, $521 million and $(1,725) million, respectively, principally related to changes in the exchange rates between the Euro and U.S. dollar. These gains (losses) were reported as a component of accumulated other comprehensive losses within currency translation adjustments and were substantially offset by the losses and gains generated on the underlying assets. For the years ended December 31, 2019 and 2018, the gains for amounts excluded from the effectiveness testing recognized in earnings were $230 million and $260 million, respectively. These gains were accounted for in interest expense, net, on the consolidated statement of earnings. The premiums paid for, and settlements of, net investment hedges are included in investing cash flows on PMI’s consolidated statements of cash flows.

Other Derivatives

PMI has entered into derivative contracts to hedge the foreign currency exchange and interest rate risks related to intercompany loans between certain subsidiaries, and third-party loans. While effective as economic hedges, no hedge accounting is applied for these contracts; therefore, the unrealized gains (losses) relating to these contracts are reported in marketing, administration and research costs in PMI’s consolidated statements of earnings. For the years ended December 31, 2019, 2018 and 2017, the gains (losses) from contracts for which PMI did not apply hedge accounting were $(57) million, $405 million and $382 million, respectively. The gains (losses) from these contracts substantially offset the losses and gains generated by the underlying intercompany and third-party loans being hedged.

As a result, for the years ended December 31, 2019, 2018 and 2017, these items impacted the consolidated statement of earnings as follows:



(pre-tax, in millions)
Derivatives not Designated as Hedging Instruments	Statement of Earnings Classification of Gain/(Loss)	Amount of Gain/(Loss) Recognized in Earnings
		2019		2018		2017
Derivative contracts
	Interest expense, net	$	94	$	62	$	(60	)
Total		$	94	$	62	$	(60	)

Qualifying Hedging Activities Reported in Accumulated Other Comprehensive Losses

Derivative gains or losses reported in accumulated other comprehensive losses are a result of qualifying hedging activity. Transfers of these gains or losses to earnings are offset by the corresponding gains or losses on the underlying hedged item. Hedging activity affected accumulated other comprehensive losses, net of income taxes, as follows:



	For the Years Ended December 31,
(in millions)	2019			2018			2017
Gain as of January 1,	$	35		$	42		$	97
Derivative (gains)/losses transferred to earnings	(14		)	(31		)	(11		)
Change in fair value	(18		)	24			(44		)
Gain as of December 31,	$	3		$	35		$	42

At December 31, 2019, PMI expects $22 million of derivative gains that are included in accumulated other comprehensive losses to be reclassified to the consolidated statement of earnings within the next 12 months. These gains are expected to be substantially offset by the statement of earnings impact of the respective hedged transactions.

Contingent Features

PMI’s derivative instruments do not contain contingent features.

Credit Exposure and Credit Risk

PMI is exposed to credit loss in the event of non-performance by counterparties. While PMI does not anticipate non-performance, its risk is limited to the fair value of the financial instruments less any cash collateral received or pledged. PMI actively monitors its exposure to credit risk through the use of credit approvals and credit limits and by selecting and continuously monitoring a diverse group of major international banks and financial institutions as counterparties.

Fair Value

See Note 16. Fair Value Measurements and Note 19. Balance Sheet Offsetting for additional discussion of derivative financial instruments.