24. DERIVATIVE FINANCIAL INSTRUMENTS

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, inflation 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 risk by entering into transactions with highly rated counterparties. The Company manages the market risk by establishing and monitoring limits as to the types and degrees of risk that may be undertaken. The Company monitors its use of derivatives 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. The Company's inflation risk management strategy involves the use of swaps that requires the Company to pay a fixed rate and receive a floating rate that is based on changes in the Consumer Price Index ("CPI").

Derivatives Related to Risk Mitigation of Variable Annuity Contracts

The Company may use the following types of derivative contracts to mitigate its exposure to certain guaranteed benefits related to VA contracts and fixed indexed annuities:

•	Foreign Currency Futures
•	Variance Swaps
•	Interest Rate Futures
•	Equity Options
•	Equity Futures
•	Credit Derivatives
•	Interest Rate Swaps
•	Interest Rate Swaptions
•	Volatility Futures
•	Volatility Options
•	Total Return Swaps

Accounting for Derivative Instruments

The Company records its derivative financial instruments in the consolidated balance sheet in "other long-term investments" and "other liabilities" in accordance with GAAP, which requires that all derivative instruments be recognized in the balance sheet at fair value. 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.

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 and reclassified into earnings in the same period during which the hedged item impacts earnings. Any remaining gain or loss, the ineffective portion, is recognized in current earnings. 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 earnings. 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 earnings in the period of change. Changes in the fair value of derivatives that are recognized in current earnings are reported in "Realized investment gains (losses)—Derivative financial instruments".

Derivative Instruments Designated and Qualifying as Hedging Instruments

Cash-Flow Hedges

•

In connection with the issuance of inflation-adjusted funding agreements, the Company has entered into swaps to essentially convert the floating CPI-linked interest rate on these agreements to a fixed rate. The Company pays a fixed rate on the swap and receives a floating rate primarily determined by the period's change in the CPI. The amounts that are received on the swaps are almost equal to the amounts that are paid on the agreements.

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 earnings during the period of change.

Derivatives Related to Variable Annuity Contracts

•	The Company uses equity, interest rate, currency, and volatility futures to mitigate the risk related to certain guaranteed minimum benefits, including GMWB, 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. No volatility future positions were held as of December 31, 2014.
•	The Company uses equity options, volatility swaps, and volatility options to mitigate the risk related to certain guaranteed minimum benefits, including GMWB, within its VA products. In general, the cost of such benefits varies with the level of equity markets and overall volatility. No volatility option positions were held as of December 31, 2014.
•	The Company uses interest rate swaps and interest rate swaptions to mitigate the risk related to certain guaranteed minimum benefits, including GMWB, within its VA products.
•	The Company markets certain VA products with a GMWB rider. The GMWB component is considered an embedded derivative, not considered to be clearly and closely related to the host contract. During the year ended December 31, 2014 the Company experienced realized losses on the GMWB embedded derivative of $401.4 million. These losses were impacted by changes in the policyholder behavior assumptions, primarily the lowering lapse rates and increased utilization rates, used to value the GMWB embedded derivatives.

Derivatives Related to Fixed Annuity Contracts

•	The Company uses equity and volatility futures 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 uses equity options to mitigate the risk within its fixed indexed annuity products. In general, the cost of such benefits varies with the level of equity markets.
•	The Company markets certain fixed indexed annuity products. The FIA component is considered an embedded derivative, not considered to be clearly and closely related to the host contract.

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, not considered to be clearly and closely related to the host contract.

Other Derivatives

•	The Company uses certain interest rate swaps to mitigate the price volatility of fixed maturities. None of these positions were held as of December 31, 2014.
•	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 arrangements which contain embedded derivatives. Changes in their fair value are recorded in current period earnings. The investment portfolios that support the related modified coinsurance reserves had fair value changes which substantially offset the gains or losses on these embedded derivatives.

The following table sets forth realized investment gains and losses for the periods shown:

Realized investment gains (losses)—derivative financial instruments

	For The Year Ended December 31,
	2014			2013			2012
	(Dollars In Thousands)
Derivatives related to variable annuity contracts:
Interest rate futures—VA	$	27,801		$	(31,216	)	$	21,138
Equity futures—VA		(26,104	)		(52,640	)		(50,797	)
Currency futures—VA		14,433			(469	)		(2,763	)
Volatility futures—VA		—			—			(132	)
Variance swaps—VA		(744	)		(11,310	)		(11,792	)
Equity options—VA		(41,216	)		(95,022	)		(37,370	)
Volatility options—VA		—			(115	)		—
Interest rate swaptions—VA		(22,280	)		1,575			(2,260	)
Interest rate swaps—VA		214,164			(157,408	)		3,264
Embedded derivative—GMWB		(401,354	)		325,497			(22,120	)

Total derivatives related to variable annuity contracts		(235,300	)		(21,108	)		(102,832	)
Derivatives related to FIA contracts:
Embedded derivative—FIA		(16,932	)		(942	)		—
Equity futures—FIA		870			173			—
Volatility futures—FIA		20			(5	)		—
Equity options—FIA		9,906			1,866			—

Total derivatives related to FIA contracts		(6,136	)		1,092			—
Derivatives related to IUL contracts:
Embedded derivative—IUL		(8	)		—			—
Equity futures—IUL		15			—			—
Equity options—IUL		150			—			—

Total derivatives related to IUL contracts		157			—			—
Embedded derivative—Modco reinsurance treaties		(105,276	)		205,176			(132,816	)
Interest rate swaps		—			2,985			(87	)
Interest rate caps		—			—			(2,666	)
Other derivatives		(323	)		(14	)		(79	)

Total realized gains (losses)—derivatives	$	(346,878	)	$	188,131		$	(238,480	)

The following table sets forth realized investment gains and losses for the Modco trading portfolio that is included in realized investment gains (losses)—all other investments:

Realized investment gains (losses)—all other investments

		For The Year Ended December 31,
		2014		2013			2012
		(Dollars In Thousands)
Modco trading portfolio(1)		$	142,016	$	(178,134	)	$	177,986
(1)	The Company elected to include the use of alternate disclosures for trading activities.

The following tables present the components of the gain or loss on derivatives that qualify as a cash flow hedging relationship:

Gain (Loss) on Derivatives in Cash Flow 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 (Losses) Recognized in Income (Loss) on Derivatives
	(Effective Portion)			(Effective Portion)			(Ineffective Portion)
				Benefits and settlement expenses			Realized investment gains (losses)
	(Dollars In Thousands)
For The Year Ended December 31, 2014
Inflation	$	(4	)	$	(1,777	)	$	(223	)

Total	$	(4	)	$	(1,777	)	$	(223	)


For The Year Ended December 31, 2013
Inflation	$	1,130		$	(2,349	)	$	(190	)

Total	$	1,130		$	(2,349	)	$	(190	)

The tables below present information about the nature and accounting treatment of the Company's primary derivative financial instruments and the location in and effect on the consolidated financial statements for the periods presented below:

	As of December 31,
	2014				2013
	Notional Amount		Fair Value		Notional Amount		Fair Value
	(Dollars In Thousands)
Other long-term investments
Derivatives not designated as hedging instruments:
Interest rate swaps	$	1,550,000	$	50,743	$	200,000	$	1,961
Embedded derivative—Modco reinsurance treaties		25,760		1,051		80,376		1,517
Embedded derivative—GMWB		2,804,629		66,843		6,113,017		194,616
Interest rate futures		27,977		938		—		—
Equity futures		26,483		427		3,387		111
Currency futures		197,648		2,384		14,338		321
Equity options		1,921,167		163,212		1,376,205		78,277
Interest rate swaptions		625,000		8,012		625,000		30,291
Other		242		360		425		473

	$	7,178,906	$	293,970	$	8,412,748	$	307,567


Other liabilities
Cash flow hedges:
Inflation	$	40,469	$	142	$	182,965	$	1,865
Derivatives not designated as hedging instruments:
Interest rate swaps		275,000		3,599		1,230,000		153,322
Variance swaps		—		—		1,500		1,744
Embedded derivative—Modco reinsurance treaties		2,562,848		311,727		2,578,590		206,918
Embedded derivative—GMWB		7,038,228		311,969		2,494,142		38,388
Embedded derivative—FIA		749,933		124,465		244,424		25,324
Embedded derivative—IUL		12,019		6,691		—		—
Interest rate futures		—		—		322,902		5,221
Equity futures		385,256		15,069		164,595		6,595
Currency futures		—		—		118,008		840
Equity options		699,295		47,077		257,065		17,558
Other		—		—		230		27

	$	11,763,048	$	820,739	$	7,594,421	$	457,802

Based on the expected cash flows of the underlying hedged items, the Company expects to reclassify $0.1 million out of accumulated other comprehensive income (loss) into earnings during the next twelve months.