Derivative Financial Instruments

The carrying amounts of derivative instruments, including derivative instruments embedded in FIA contracts, is as follows:



	September 30, 2018		December 31, 2017
Assets:
Derivative investments:
Call options	$	431	$	492
Futures contracts	—		—
Foreign currency forward	1		—
Other invested assets:
Other derivatives and embedded derivatives	17		17
	$	449	$	509



Liabilities:
Contractholder funds:
FIA embedded derivative	$	2,551	$	2,277
Other liabilities:
Preferred shares reimbursement feature embedded derivative	22		23
	$	2,573	$	2,300

The change in fair value of derivative instruments included in the accompanying Condensed Consolidated Statements of Operations is as follows:



	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017
				Predecessor						Predecessor
Revenues:
Net investment gains (losses):
Call options	$	153		$	113		$	86		$	299
Futures contracts	8			5			8			10
Foreign currency forward	1			—			1			—
Other derivatives and embedded derivatives	—			1			—			3
Reinsurance related embedded derivatives (a)	(3		)	(8		)	(37		)	(28		)
Total net investment gains (losses)	$	159		$	111		$	58		$	284

Benefits and other changes in policy reserves:
FIA embedded derivatives	$	231		$	185		$	274		$	377

Acquisition and operating expenses, net of deferrals:
Preferred shares reimbursement feature embedded derivative (b)	$	2		$	—		$	1		$	—

(a) Change in fair value of reinsurance related embedded derivatives in the successor period is due to FSRC unaffiliated third party business and the predecessor periods activity is due to the FGL and FSRC reinsurance treaty.

(b) Only applicable to Successor periods.

Additional Disclosures

Other Derivatives and Embedded Derivatives

The Company holds a $35 fund-linked note issued by Nomura International Funding Pte. Ltd. The note provides for an additional payment at maturity based on the value of an embedded derivative in AnchorPath Dedicated Return Fund (the "AnchorPath Fund") of $11 which was based on the actual return of the fund. At September 30, 2018, the fair value of the fund-linked note and embedded derivative were $25 and $17, respectively. At maturity of the fund-linked note, FGL Insurance will receive the $35 face value of the note plus the value of the embedded derivative in the AnchorPath Fund. The additional payment at maturity is an embedded derivative reported in "Other invested assets", while the host is an available-for-sale security reported in "Fixed maturities, available-for-sale".

Fixed Index Annuity ("FIA") Embedded Derivative and Call Options and Futures

The Company has 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 Condensed Consolidated Balance Sheets with changes in fair value included as a component of “Benefits and other changes in policy reserves” in the Condensed Consolidated Statements of Operations. See a description of the fair value methodology used in "Note 6. Fair Value of Financial Instruments".

The Company purchases 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 the Company purchases new one, two, three, or five year call options to fund the next index credit. The Company manages the cost of these purchases through the terms of its FIA contracts, which permit the Company 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. The call options and futures contracts are marked to fair value with the change in fair value included as a component of “Net investment gains (losses).” 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 the Company’s risk tolerance. The Company’s FIA hedging strategy economically hedges the equity returns and exposes the Company to the risk that unhedged market exposures result in divergence between changes in the fair value of the liabilities and the hedging assets. The Company uses a variety of techniques, including direct estimation of market sensitivities and value-at-risk to monitor this risk daily. The Company intends to continue to adjust the hedging strategy as market conditions and the Company’s risk tolerance change.

Preferred Equity Remarketing Reimbursement Embedded Derivative Liability

On November 30, 2017 the Company issued 275,000 Series A cumulative preferred shares and 100,000 Series B cumulative preferred shares (together the “Preferred Shares”). The Preferred Shares do not have a maturity date and are non-callable for the first five years. From and after November 30, 2022, the original holders of the Preferred Shares may request and thus require, the Company (subject to customary blackout provisions) to remarket the Preferred Shares on their existing terms. If the remarketing is successful and the original holders elect to sell their preferred shares at the remarketed price and proceeds from such sale are less than the outstanding balance of the applicable shares (including dividends paid in kind and accumulated but unpaid dividends), the Company will be required to reimburse the sellers, up to a maximum of 10% of the par value of the originally issued preferred shares (including dividends paid in kind and accumulated but unpaid dividends) with such amount payable either in cash, ordinary shares, or any combination thereof, at the Company's option (the “Reimbursement Feature”). The Reimbursement Feature represents an embedded derivative that is not clearly and closely related to the preferred stock host and must be bifurcated. The Reimbursement Feature liability is held at fair value within “Other liabilities” in the accompanying Condensed Consolidated Balance Sheets using a Black Derman Toy model incorporating among other things the paid in kind dividend coupon rate and the Company’s call option. Changes in fair value of this derivative are recognized within “Acquisition and operating expenses, net of deferrals” in the accompanying Condensed Consolidated Statements of Operations.

Foreign Currency Forward

On September 28, 2018, the Company entered into a foreign currency forward contract to economically hedge against unfavorable movements in EUR on an affiliated limited partnership. Under the forward contract, the price is agreed upon at the time of the contract and payment is made at a specified future date. The value of the forward was $1 at September 30, 2018 which is equal to the cumulative unrealized value and is reflected in “Derivative Instruments” with the changes in the fair value reflected in “Net investment gains”. The Company had realized net investment gains of $1 for the nine months ended September, 30, 2018 related to the forward contract.

Credit Risk

The Company is 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. The Company maintains a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.

Information regarding the Company’s exposure to credit loss on the call options it holds is presented in the following table:



		September 30, 2018
Counterparty	Credit Rating (Fitch/Moody's/S&P) (a)	Notional Amount		Fair Value		Collateral		Net Credit Risk
Merrill Lynch	A+/*/A+	$	3,515	$	129	$	89	$	40
Deutsche Bank	A-/A3/BBB+	1,286		46		47		(1		)
Morgan Stanley	*/A1/A+	1,969		66		72		(6		)
Barclay's Bank	A/Baa3/BBB	1,387		65		42		23
Canadian Imperial Bank of Commerce	*/Aa2/A+	2,376		81		82		(1		)
Wells Fargo	A+/A2/A-	1,063		37		37		—
Goldman Sachs	A/A3/BBB+	309		7		8		(1		)
Total		$	11,905	$	431	$	377	$	54



		December 31, 2017
Counterparty	Credit Rating (Fitch/Moody's/S&P) (a)	Notional Amount		Fair Value		Collateral		Net Credit Risk
Merrill Lynch	A/*/A+	$	2,780	$	150	$	118	$	32
Deutsche Bank	A-/A3/A-	1,345		51		55		(4		)
Morgan Stanley	*/A1/A+	1,555		92		101		(9		)
Barclay's Bank	A*+/A1/A	2,090		103		95		8
Canadian Imperial Bank of Commerce	AA-/Aa3/A+	2,807		96		98		(2		)
Total		$	10,577	$	492	$	467	$	25

(a) 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 September 30, 2018 and December 31, 2017, counterparties posted $377 and $467 of collateral, respectively, of which $288 and $349 is included in "Cash and cash equivalents" with an associated payable for this collateral included in "Other liabilities" on the Condensed Consolidated Balance Sheets. The remaining $89 and $118 of non-cash collateral was held by a third-party custodian and may not be sold or re-pledged, except in the event of default, and, therefore, is not included in the Company's Condensed Consolidated Balance Sheets at September 30, 2018 and December 31, 2017, respectively. This collateral generally consists of U.S. treasury bonds and mortgage-backed securities. 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 and $25 at September 30, 2018 and December 31, 2017, respectively.

The Company is required to pay counterparties the effective federal funds rate each day for cash collateral posted to FGL for daily mark to market margin changes. In June 2017, the Company began reinvesting derivative cash collateral to reduce the interest cost. Cash collateral is invested in short term Treasury securities and A1/P1 commercial paper which are included in "Cash and cash equivalents" in the accompanying Condensed Consolidated Balance Sheets.

The Company held 1,029 and 1,754 futures contracts at September 30, 2018 and December 31, 2017, respectively. 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 Condensed Consolidated Balance Sheets. The amount of cash collateral held by the counterparties for such contracts was $6 and $8 at September 30, 2018 and December 31, 2017, respectively.

Reinsurance Related Embedded Derivatives (Predecessor)

FGL Insurance has a coinsurance arrangement with FSRC, meaning that funds are withheld by FGL Insurance as the legal owner, but the credit risk is borne by FSRC. This arrangement created an obligation for FGL Insurance to pay FSRC at a later date, which resulted in an embedded derivative. This embedded derivative was considered a total return swap with contractual returns that were attributable to the assets and liabilities associated with this reinsurance arrangement. The fair value of the total return swap was 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 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 was reported in “Other assets”, if in a net gain position, or "Other liabilities", if in a net loss position, on the Predecessor's Condensed Consolidated Balance Sheets and the related gains or losses were reported in “Net investment gains” on the Predecessor's Condensed Consolidated Statements of Operations. Due to the acquisition of FSRC, the reinsurance related embedded derivative is eliminated in consolidation in the Successor periods.

Call option payable to FSRC (Predecessor)

Under the terms of the coinsurance arrangement with FSRC, FGL Insurance is required to pay FSRC a portion of the net cost of equity option purchases and the proceeds from expirations related to the equity options which hedged the index credit feature of the reinsured FIA contracts. Accordingly, the payable to FSRC was reflected in "Funds withheld for reinsurance liabilities" as of the balance sheet date with changes in fair value reflected within the “Net investment gains (losses)” in Predecessor's Condensed Consolidated Statements of Operations. Due to the acquisition of FSRC, the call option payable to FSRC is eliminated in consolidation in the Successor periods.