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DERIVATIVES AND HEDGE ACCOUNTING
 12 Months Ended
Dec. 31, 2015
DERIVATIVES AND HEDGE ACCOUNTING  
DERIVATIVES AND HEDGE ACCOUNTING

10. DERIVATIVES AND HEDGE ACCOUNTING

We use derivatives and other financial instruments as part of our financial risk management programs and as part of our investment operations. Interest rate derivatives (such as interest rate swaps) are used to manage interest rate risk associated with embedded derivatives contained in insurance contract liabilities, fixed maturity securities, outstanding medium- and long-term notes as well as other interest rate sensitive assets and liabilities. Foreign exchange derivatives (principally foreign exchange swaps and forwards) are used to economically mitigate risk associated with non-U.S. dollar denominated debt, net capital exposures, and foreign currency transactions. Equity derivatives are used to mitigate financial risk embedded in certain insurance liabilities. The derivatives are effective economic hedges of the exposures that they are meant to offset. In addition to hedging activities, we also enter into derivative instruments as a part of our investment operations, which may include, among other things, CDSs and purchases of investments with embedded derivatives, such as equity-linked notes and convertible bonds.

Interest rate, currency, equity and commodity swaps, credit contracts, swaptions, options and forward transactions are accounted for as derivatives, recorded on a trade-date basis and carried at fair value. Unrealized gains and losses are reflected in income, when appropriate. Aggregate asset or liability positions are netted on the Consolidated Balance Sheets only to the extent permitted by qualifying master netting arrangements in place with each respective counterparty. Cash collateral posted with counterparties in conjunction with transactions supported by qualifying master netting arrangements is reported as a reduction of the corresponding net derivative liability, while cash collateral received in conjunction with transactions supported by qualifying master netting arrangements is reported as a reduction of the corresponding net derivative asset.

Effective July 1, 2015, we reclassified derivatives, with the exception of embedded derivatives, in the Consolidated Balance Sheets from Derivative assets, at fair value and Derivative liabilities, at fair value to Other assets and Other liabilities, respectively. This change had no effect on the measurement of these derivatives, which continue to be measured at fair value. Embedded derivatives continue to be generally presented with the host contract in the Consolidated Balance Sheets. A bifurcated embedded derivative is measured at fair value and accounted for in the same manner as a free standing derivative contract. The corresponding host contract is accounted for according to the accounting guidance applicable for that instrument. See Notes 4 and 13 herein for additional information on embedded derivatives.

The following table presents the notional amounts of our derivatives and the fair value of derivative assets and liabilities in the Consolidated Balance Sheets:

December 31, 2015December 31, 2014
Gross Derivative AssetsGross Derivative LiabilitiesGross Derivative AssetsGross Derivative Liabilities
NotionalFairNotionalFairNotionalFairNotionalFair
(in millions)AmountValueAmountValueAmountValueAmountValue
Derivatives designated as
hedging instruments:(a)
Interest rate contracts$301$1$725$2$155$-$25$2
Foreign exchange contracts2,90320791456611251,794239
Equity contracts--121237110413
Derivatives not designated
as hedging instruments:(a)
Interest rate contracts45,8463,16165,7332,19765,0703,74345,1043,131
Foreign exchange contracts9,4725598,9001,14813,6678158,5161,251
Equity contracts6,6561775,028457,5652063,04990
Commodity contracts----15-116
Credit contracts(b) 431,289508545,288982
Other contracts(c)37,586232036936,1553153890
Total derivatives, gross$102,768$4,131$82,913$4,048$123,250$4,825$64,429$5,804
Counterparty netting(d) (1,268)(1,268)(2,102)(2,102)
Cash collateral(e)(1,554)(760)(1,119)(1,429)
Total derivatives on
consolidated balance sheets(f)$1,309$2,020$1,604$2,273

(a) Fair value amounts are shown before the effects of counterparty netting adjustments and offsetting cash collateral.

(b) As of December 31, 2015 and 2014, included super senior multi-sector CDOs with a net notional amount of $1.1 billion and $2.6 billion (fair value liability of $483 million and $947 million), respectively. The expected weighted average maturity as of December 31, 2015 is six years. Because of long-term maturities of the CDSs in the portfolio, we are unable to make reasonable estimates of the periods during which any payments would be made. However, the net notional amount represents the maximum exposure to loss on the portfolio. As of December 31, 2015, there were no super senior corporate debt/CLOs remaining. As of December 31, 2014, included super senior corporate debt/CLOs with a net notional amount of $2.5 billion (fair value liability of $7 million).

(c) Consists primarily of stable value wraps and contracts with multiple underlying exposures.

(d) Represents netting of derivative exposures covered by a qualifying master netting agreement.

(e) Represents cash collateral posted and received that is eligible for netting.

(f) Freestanding derivatives only, excludes Embedded derivatives. Derivative instrument assets and liabilities are recorded in Other Assets and Liabilities, respectively. Fair value of assets related to bifurcated Embedded derivatives was zero at both December 31, 2015 and December 31, 2014. Fair value of liabilities related to bifurcated Embedded derivatives was $2.3 billion and $1.6 billion, respectively, at December 31, 2015 and December 31, 2014. A bifurcated Embedded derivative is generally presented with the host contract in the Consolidated Balance Sheets. Embedded derivatives are primarily related to guarantee features in variable annuity products, which include equity and interest rate components.

Collateral

We engage in derivative transactions that are not subject to a clearing requirement directly with unaffiliated third parties, in most cases, under International Swaps and Derivatives Association, Inc. (ISDA) Master Agreements. Many of the ISDA Master Agreements also include Credit Support Annex (CSA) provisions, which provide for collateral postings that may vary at various ratings and threshold levels. We attempt to reduce our risk with certain counterparties by entering into agreements that enable collateral to be obtained from a counterparty on an upfront or contingent basis. We minimize the risk that counterparties might be unable to fulfill their contractual obligations by monitoring counterparty credit exposure and collateral value and generally requiring additional collateral to be posted upon the occurrence of certain events or circumstances. In addition, certain derivative transactions have provisions that require collateral to be posted upon a downgrade of our long-term debt ratings or give the counterparty the right to terminate the transaction. In the case of some of the derivative transactions, upon a downgrade of our long-term debt ratings, as an alternative to posting collateral and subject to certain conditions, we may assign the transaction to an obligor with higher debt ratings or arrange for a substitute guarantee of our obligations by an obligor with higher debt ratings or take other similar action. The actual amount of collateral required to be posted to counterparties in the event of such downgrades, or the aggregate amount of payments that we could be required to make, depends on market conditions, the fair value of outstanding affected transactions and other factors prevailing at and after the time of the downgrade.

Collateral posted by us to third parties for derivative transactions was $3.0 billion and $3.3 billion at December 31, 2015 and 2014, respectively. In the case of collateral posted under derivative transactions that are not subject to clearing, this collateral can generally be repledged or resold by the counterparties. Collateral provided to us from third parties for derivative transactions was $1.6 billion and $1.3 billion at December 31, 2015 and 2014, respectively. We generally can repledge or resell collateral.

Offsetting

We have elected to present all derivative receivables and derivative payables, and the related cash collateral received and paid, on a net basis on our Consolidated Balance Sheets when a legally enforceable ISDA Master Agreement exists between us and our derivative counterparty. An ISDA Master Agreement is an agreement governing multiple derivative transactions between two counterparties. The ISDA Master Agreement generally provides for the net settlement of all, or a specified group, of these derivative transactions, as well as transferred collateral, through a single payment, and in a single currency, as applicable. The net settlement provisions apply in the event of a default on, or affecting any, one derivative transaction or a termination event affecting all, or a specified group of, derivative transactions governed by the ISDA Master Agreement.

Hedge Accounting

We designated certain derivatives entered into with third parties as fair value hedges of available for sale investment securities held by our insurance subsidiaries. The fair value hedges include foreign currency forwards and cross currency swaps designated as hedges of the change in fair value of foreign currency denominated available for sale securities attributable to changes in foreign exchange rates. We also designated certain interest rate swaps entered into with third parties as fair value hedges of fixed rate GICs attributable to changes in benchmark interest rates.

We use foreign currency denominated debt and cross-currency swaps as hedging instruments in net investment hedge relationships to mitigate the foreign exchange risk associated with our non-U.S. dollar functional currency foreign subsidiaries. For net investment hedge relationships where issued debt is used as a hedging instrument, we assess the hedge effectiveness and measure the amount of ineffectiveness based on changes in spot rates. For net investment hedge relationships that use derivatives as hedging instruments, we assess hedge effectiveness and measure hedge ineffectiveness using changes in forward rates. For the years ended December 31, 2015, 2014, and 2013 we recognized gains of $90 million and $156 million and a loss of $38 million, respectively, included in Change in foreign currency translation adjustment in Other comprehensive income related to the net investment hedge relationships.

A qualitative methodology is utilized to assess hedge effectiveness for net investment hedges, while regression analysis is employed for all other hedges.

The following table presents the gain (loss) recognized in earnings on our derivative instruments in fair value hedging relationships in the Consolidated Statements of Income:

Gains/(Losses) Recognized in Earnings for:Including Gains/(Losses) Attributable to:
HedgingHedgedHedgeExcluded
(in millions)Derivatives(a)ItemsIneffectivenessComponentsOther(b)
Year ended December 31, 2015
Interest rate contracts:
Realized capital gains/(losses)$-$1$1$-$-
Interest credited to policyholder
account balances-----
Other income-9--9
Gain/(Loss) on extinguishment of debt-14--14
Foreign exchange contracts:
Realized capital gains/(losses)202(167)-323
Interest credited to policyholder
account balances-(1)--(1)
Other income-17--17
Gain/(Loss) on extinguishment of debt-17--17
Equity contracts:
Realized capital gains/(losses)(45)45---
Year ended December 31, 2014
Interest rate contracts:
Realized capital gains/(losses)$1$(2)$-$-$(1)
Interest credited to policyholder
account balances-(1)--(1)
Other income-43--43
Gain/(Loss) on extinguishment of debt-164--164
Foreign exchange contracts:
Realized capital gains/(losses)(129)147-810
Interest credited to policyholder
account balances-(3)--(3)
Other income-23--23
Gain/(Loss) on extinguishment of debt-2--2
Equity contracts:
Realized capital gains/(losses)(23)22-(1)-
Year ended December 31, 2013
Interest rate contracts:
Realized capital gains/(losses)$(5)$5$-$-$-
Interest credited to policyholder
account balances-(2)--(2)
Other income-99--99
Foreign exchange contracts:
Realized capital gains/(losses)(187)204-17-

(a) The amounts presented do not include the periodic net coupon settlements of the derivative contract or the coupon income (expense) related to the hedged item.

(b) Represents accretion/amortization of opening fair value of the hedged item at inception of hedge relationship, amortization of basis adjustment on hedged item following the discontinuation of hedge accounting, and the release of debt basis adjustment following the repurchase of issued debt that was part of previously-discontinued fair value hedge relationship.

Derivatives Not Designated as Hedging Instruments

The following table presents the effect of derivative instruments not designated as hedging instruments in the Consolidated Statements of Income:

Gains (Losses)
Years Ended December 31,Recognized in Earnings
(in millions)201520142013
By Derivative Type:
Interest rate contracts$339$851$(259)
Foreign exchange contracts41630941
Equity contracts(182)(274)(507)
Commodity contracts(1)(1)(4)
Credit contracts186263567
Other contracts6919285
Embedded derivatives49(841)1,099
Total$876$499$1,022
By Classification:
Policy fees$78$-$-
Net investment income2610228
Net realized capital gains (losses)365(219)257
Other income401599750
Policyholder benefits and claims incurred617(13)
Total$876$499$1,022

Credit Risk-Related Contingent Features

The aggregate fair value of our derivative instruments that contain credit risk-related contingent features that were in a net liability position at December 31, 2015 and 2014, was approximately $2.0 billion and $2.5 billion, respectively. The aggregate fair value of assets posted as collateral under these contracts at December 31, 2015 and 2014, was $2.1 billion and $2.7 billion, respectively.

We estimate that at December 31, 2015, based on our outstanding financial derivative transactions, a one-notch downgrade of our long-term senior debt ratings to BBB+ by Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. (S&P), would permit counterparties to make additional collateral calls and permit certain counterparties to elect early termination of contracts, resulting in a negligible amount of corresponding collateral postings and termination payments; a one-notch downgrade to Baa2 by Moody’s Investors’ Service, Inc. (Moody’s) and an additional one-notch downgrade to BBB by S&P would result in approximately $44 million in additional collateral postings and termination payments, and a further one-notch downgrade to Baa3 by Moody’s and BBB– by S&P would result in approximately $95 million in additional collateral postings and termination payments.

Additional collateral postings upon downgrade are estimated based on the factors in the individual collateral posting provisions of the CSA with each counterparty and current exposure as of December 31, 2015. Factors considered in estimating the termination payments upon downgrade include current market conditions, the complexity of the derivative transactions, historical termination experience and other observable market events such as bankruptcy and downgrade events that have occurred at other companies. Our estimates are also based on the assumption that counterparties will terminate based on their net exposure to us. The actual termination payments could significantly differ from our estimates given market conditions at the time of downgrade and the level of uncertainty in estimating both the number of counterparties who may elect to exercise their right to terminate and the payment that may be triggered in connection with any such exercise.

Hybrid Securities with Embedded Credit Derivatives

We invest in hybrid securities (such as credit-linked notes) with the intent of generating income, and not specifically to acquire exposure to embedded derivative risk. As is the case with our other investments in RMBS, CMBS, CDOs and ABS, our investments in these hybrid securities are exposed to losses only up to the amount of our initial investment in the hybrid security. Other than our initial investment in the hybrid securities, we have no further obligation to make payments on the embedded credit derivatives in the related hybrid securities.

We elect to account for our investments in these hybrid securities with embedded written credit derivatives at fair value, with changes in fair value recognized in Net investment income and Other income. Our investments in these hybrid securities are reported as Other bond securities in the Consolidated Balance Sheets. The fair values of these hybrid securities were $5.7 billion and $6.1 billion at December 31, 2015 and 2014, respectively. These securities have par amounts of $11.2 billion and $12.3 billion at December 31, 2015 and 2014, respectively, and have remaining stated maturity dates that extend to 2055.