DERIVATIVE FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Types of Derivative Instruments and Derivative Strategies

The Company utilizes a risk management strategy that incorporates the use of derivative financial instruments to reduce exposure to certain risks, including but not limited to, interest rate risk, currency exchange risk, volatility risk, and equity market risk. These strategies are developed through the Company’s analysis of data from financial simulation models and other internal and industry sources, and are then incorporated into the Company’s risk management program.

Derivative instruments expose the Company to credit and market risk and could result in material changes from period to period. The Company attempts to minimize its credit in connection with its overall asset/liability management programs and risk management strategies. In addition, all derivative programs are monitored by our risk management department.

Derivatives Related to Interest Rate Risk Management

Derivative instruments that are used as part of the Company’s interest rate risk management strategy include interest rate swaps, interest rate futures, interest rate caps, and interest rate swaptions.

Derivatives Related to Foreign Currency Exchange Risk Management

Derivative instruments that are used as part of the Company’s foreign currency exchange risk management strategy include foreign currency swaps, foreign currency futures, foreign equity futures, and foreign equity options.

Derivatives Related to Risk Mitigation of Certain Annuity Contracts

The Company may use the following types of derivative contracts to mitigate its exposure to certain guaranteed benefits related to variable annuity (“VA”) contracts, fixed indexed annuities, and indexed universal life contracts:

•Foreign Currency Futures

•Variance Swaps

•Interest Rate Futures

•Equity Options

•Equity Futures

•Credit Derivatives

•Interest Rate Swaps

•Interest Rate Swaptions

•Volatility Futures

•Volatility Options

•Funds Withheld Agreements

•Total Return Swaps

•Foreign Currency Options

Other Derivatives

The Company and certain of its subsidiaries have derivatives with PLC. These derivatives consist of an interest support agreement, YRT premium support agreements, and portfolio maintenance agreements with PLC.

The Company has a funds withheld account that consists of various derivative instruments held by the Company that are used to hedge the GLWB and GMDB riders and the fixed indexed annuity products. The economic performance of derivatives in the funds withheld account is ceded to subsidiaries of PLC. The funds withheld account is accounted for as a derivative financial instrument.

Accounting for Derivative Instruments

GAAP requires that all derivative instruments be recognized in the balance sheet at fair value. The Company records its derivative financial instruments in the consolidated condensed balance sheet in other long-term investments and other liabilities. The change in the fair value of derivative financial instruments is reported either in the statement of income or in other comprehensive income (loss), depending upon whether it qualified for and also has been properly identified as being part of a hedging relationship, and also on the type of hedging relationship that exists.

It is the Company's policy not to offset assets and liabilities associated with open derivative contracts. However, the Chicago Mercantile Exchange (“CME”) rules characterize variation margin transfers as settlement payments, as opposed to adjustments to collateral. As a result, derivative assets and liabilities associated with centrally cleared derivatives for which the CME serves as the central clearing party are presented as if these derivatives had been settled as of the reporting date.

For a derivative financial instrument to be accounted for as an accounting hedge, it must be identified and documented as such on the date of designation. For cash flow hedges, the effective portion of their realized gain or loss is reported as a component of other comprehensive income (loss) and reclassified into operations in the same period during which the hedged item impacts operations. Any remaining gain or loss, the ineffective portion, is recognized in current operations. For fair value hedge derivatives, their gain or loss as well as the offsetting loss or gain attributable to the hedged risk of the hedged item is recognized in current operations. Effectiveness of the Company’s hedge relationships is assessed on a quarterly basis.

The Company reports changes in fair values of derivatives that are not part of a qualifying hedge relationship through operations in the period of change. Changes in the fair value of these derivatives are recognized in realized gains (losses) - investments/derivatives in the consolidated condensed statements of income.

Derivative Instruments Designated and Qualifying as Hedging Instruments

Cash-Flow Hedges

•To hedge a fixed rate note denominated in a foreign currency, the Company entered into a fixed-to-fixed foreign currency swap in order to hedge the foreign currency exchange risk associated with the note. The cash flows received on the swap are identical to the cash flows paid on the note.

•To hedge a floating rate note, the Company entered into an interest rate swap to exchange the floating rate on the note for a fixed rate in order to hedge the interest rate risk associated with the note. The cash flows received on the swap are identical to the cash flow variability paid on the note.

Derivative Instruments Not Designated and Not Qualifying as Hedging Instruments

The Company uses various other derivative instruments for risk management purposes that do not qualify for hedge accounting treatment. Changes in the fair value of these derivatives are recognized in realized gains (losses) - investments/derivatives in the consolidated condensed statements of income.

Derivatives Related to Variable Annuity Contracts

•The Company uses equity futures, equity options, total return swaps, interest rate futures, interest rate swaps, interest rate swaptions, currency futures, currency options, volatility futures, volatility options, and variance swaps to mitigate the risk related to certain guaranteed minimum benefits, including GLWB, within its VA products. In general, the cost of such benefits varies with the level of equity and interest rate markets, foreign currency levels, and overall volatility.

•The Company markets certain VA products with a GLWB rider. The GLWB component is considered an embedded derivative, not considered to be clearly and closely related to the host contract.

•The Company has a funds withheld account that consists of various derivative instruments held by the Company that are used to hedge the GLWB and GMDB riders. The economic performance of derivatives in the funds withheld account is ceded to Shades Creek Captive Insurance Company (“Shades Creek”), a direct wholly owned subsidiary of PLC. The funds withheld account is accounted for as a derivative financial instrument.

Derivatives Related to Fixed Annuity Contracts

•The Company uses equity futures and options to mitigate the risk within its fixed indexed annuity products. In general, the cost of such benefits varies with the level of equity and overall volatility.

•The Company markets certain fixed indexed annuity products. The FIA component is considered an embedded derivative as it is not considered to be clearly and closely related to the host contract.

•The Company has a funds withheld account that consists of various derivative instruments held by the Company that are used to hedge the fixed indexed annuity products. The economic performance of derivatives in the funds withheld account is ceded to Protective Life Reinsurance Bermuda Ltd. The funds withheld account is accounted for as a derivative financial instrument.

Derivatives Related to Indexed Universal Life Contracts

•The Company uses equity futures and options to mitigate the risk within its indexed universal life products. In general, the cost of such benefits varies with the level of equity markets.

•The Company markets certain IUL products. The IUL component is considered an embedded derivative as it is not considered to be clearly and closely related to the host contract.

Other Derivatives

•The Company and certain of its subsidiaries have an interest support agreement, YRT premium support agreements, and portfolio maintenance agreements with PLC. See Note 15, Subsequent Events for additional information on these agreements.

•The Company uses various swaps and other types of derivatives to manage risk related to other exposures.

•The Company is involved in various modified coinsurance and funds withheld arrangements which contain embedded derivatives. Changes in their fair value are recorded in realized gains (losses) - investments/derivatives in the consolidated condensed statements of income. The investment portfolios that support the related modified coinsurance reserves and funds withheld arrangements had fair value changes which substantially offset the gains or losses on these embedded derivatives.

The following table sets forth realized gains (losses) - derivatives for the periods shown:

Realized gains (losses) - derivative financial instruments


	For The Three Months Ended September 30,				For The Nine Months Ended September 30,
	2020		2019		2020		2019
	(Dollars In Thousands)
Derivatives related to VA contracts:
Interest rate futures	$	2,257	$	727	$	(3,565)	$	(16,575)
Equity futures	(1,187)		5,220		131,912		37,517
Currency futures	(9,536)		9,181		1,438		11,028
Equity options	(41,584)		(3,957)		66,647		(97,354)

Interest rate swaps	(57,657)		149,766		363,644		342,561
Total return swaps	(31,465)		(1,950)		30,680		(50,522)
Embedded derivative - GLWB	72,519		(86,635)		(332,202)		(189,624)
Funds withheld derivative	45,787		(350)		(103,494)		80,198
Total derivatives related to VA contracts	(20,866)		72,002		155,060		117,229
Derivatives related to FIA contracts:
Embedded derivative	(8,642)		(4,335)		(38,065)		(67,968)
Funds withheld derivative	(2,804)		—		(9,586)		—
Equity futures	518		962		(6,550)		964
Equity options	24,870		4,785		15,031		60,026
Other derivatives	483		—		258		—
Total derivatives related to FIA contracts	14,425		1,412		(38,912)		(6,978)
Derivatives related to IUL contracts:
Embedded derivative	15,648		6,261		1,409		(18,395)
Equity futures	(230)		91		(2,374)		347
Equity options	6,535		586		583		9,372
Total derivatives related to IUL contracts	21,953		6,938		(382)		(8,676)
Embedded derivative - Modco reinsurance treaties	(25,438)		(44,027)		(55,864)		(199,704)
Derivatives with PLC(1)	19,833		7,583		22,179		14,852
Other derivatives	5,430		(1,622)		10,818		(3,011)
Total realized gains (losses) - derivatives	$	15,337	$	42,286	$	92,899	$	(86,288)

(1) These derivatives include the Interest Support, YRT premium support, and portfolio maintenance agreements between certain of the Company’s subsidiaries and PLC.

The following table presents the components of the gain or loss on derivatives that qualify as a cash flow hedging relationship.

Gain (Loss) on Derivatives in Cash Flow Hedging Relationship


	Amount of Gains (Losses) Deferred in Accumulated Other Comprehensive Income (Loss) on Derivatives		Amount and Location of Gains (Losses) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)		Amount and Location of Gains (Losses) Recognized in Income (Loss) on Derivatives
	(Effective Portion)		(Effective Portion)		(Ineffective Portion)
			Benefits and settlement expenses		Realized gains (losses) - investments/derivatives
	(Dollars In Thousands)
For The Three Months Ended September 30, 2020
Foreign currency swaps	$	808	$	(224)	$	—
Interest rate swaps	1,121		(177)		—
Total	$	1,929	$	(401)	$	—

For The Nine Months Ended September 30, 2020
Foreign currency swaps	$	(1,316)	$	(841)	$	—
Interest rate swaps	206		(2,231)		—
Total	$	(1,110)	$	(3,072)	$	—

For The Three Months Ended September 30, 2019
Foreign currency swaps	$	(4,163)	$	(373)	$	—
Interest rate swaps	(93)		(373)		—
Total	$	(4,256)	$	(746)	$	—

For The Nine Months Ended September 30, 2019
Foreign currency swaps	$	(7,789)	$	(767)	$	—
Interest rate swaps	(2,484)		(593)		—
Total	$	(10,273)	$	(1,360)	$	—

Based on expected cash flows of the underlying hedged items, the Company expects to reclassify $1.0 million out of accumulated other comprehensive income (loss) into realized gains (losses) - investments/derivatives in the consolidated condensed statements of income during the next twelve months.

The table below presents information about the nature and accounting treatment of the Company’s primary derivative financial instruments and the location in and effect on the consolidated condensed financial statements for the periods presented below:


	As of
	September 30, 2020				December 31, 2019
	Notional Amount		Fair Value		Notional Amount		Fair Value
	(Dollars In Thousands)
Other long-term investments



Derivatives not designated as hedging instruments:
Interest rate swaps	$	1,628,000	$	210,420	$	2,228,000	$	98,655
Total return swaps	433,231		7,018		269,772		941
Derivatives with PLC(1)	2,618,962		133,486		2,830,889		115,379
Embedded derivative - Modco reinsurance treaties	1,269,954		83,379		1,280,189		31,926
Embedded derivative - GLWB	610,426		48,091		1,147,436		62,538
Embedded derivative - FIA	310,468		55,038		—		—
Interest rate futures	700,637		4,818		896,073		7,557
Equity futures	156,317		2,063		159,901		2,109
Currency futures	161,793		1,750		72,593		131
Equity options	7,740,526		861,711		6,685,670		676,257


	$	15,630,314	$	1,407,774	$	15,570,523	$	995,493
Other liabilities
Cash flow hedges:
Interest rate swaps	$	—	$	—	$	350,000	$	—
Foreign currency swaps	117,178		18,727		117,178		11,373
Derivatives not designated as hedging instruments:
Interest rate swaps	1,194,000		—		50,000		—
Total return swaps	418,088		7,112		579,675		3,229
Embedded derivative - Modco reinsurance treaties	2,892,930		331,836		2,263,685		231,516
Funds withheld derivative	3,810,657		145,030		1,845,649		70,583
Embedded derivative - GLWB	3,359,799		566,337		2,892,926		248,577
Embedded derivative - FIA	3,656,227		580,268		2,892,803		332,869
Embedded derivative - IUL	339,564		194,228		301,598		151,765
Interest rate futures	421,631		1,825		669,223		10,375
Equity futures	162,260		3,571		174,743		2,376
Currency futures	128,613		1,016		192,306		1,836
Equity options	5,465,007		507,408		4,827,714		429,434
Other	268,436		46,236		199,387		53,245
	$	22,234,390	$	2,403,594	$	17,356,887	$	1,547,178

(1) These derivatives include the Interest, YRT premium support, and portfolio maintenance agreements between certain of the Company’s subsidiaries and PLC.