Derivative Financial Instruments

9 Months Ended

Sep. 30, 2016

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

Note 9 — Derivative Financial Instruments

The Company uses derivative financial instruments to manage the characteristics ofinvestment assets (such as duration, yield, currency and liquidity)to meet the varying demands of the related insurance and contractholder liabilities(such as paying claims, investment returns and withdrawals)and to hedge interest rate risk of its long-term debt. The Company has written and purchased GMIB reinsurance contracts in its run-off reinsurance business that are accounted for as freestanding derivatives. For further information on the Company's accounting policy for derivative financial instruments, see Note 2(C) to the Consolidated Financial Statements contained in the Company's 2015 Form 10-K. Derivatives in the Company's separate accounts are excluded from the following discussion because associated gains and losses generally accrue directly to separate account policyholders.

Collateral and termination features.The Company routinely monitors exposure to credit risk associated with derivatives and diversifies the portfolio among approved dealers of high credit quality to minimize this risk. As of September 30, 2016, the Company had $14 million in cash on deposit representing the upfront margin required for the Company's centrally-cleared derivative instruments.Certain of the Company's over-the-counter derivative instruments contain provisions requiring either the Company or the counterparty to post collateral or demand immediate payment depending on the amount of the net liability position and predefined financial strength or credit rating thresholds. Collateral posting requirements vary by counterparty. The net asset or liability positions of these derivatives were not material as of September 30, 2016 or December 31, 2015.

Investment Cash Flow and Fair Value Hedges

Using cash flow hedge accounting, the Company entered into interest rate, foreign currency, and combination (interest rate and foreign currency) swap contracts to hedge the interest and foreign currency cash flows of its fixed maturity bonds to match associated insurance liabilities. Fair values are reported in other long-term investments or accounts payable, accrued expenses and other liabilities. Changes in fair value are reported in accumulated other comprehensive income and amortized into net investment income or reported in other realized investment gains and losses as interest or principal payments are received.

Beginning in the second quarter of 2016, the Company entered into a foreign currency swap contract to hedge the foreign exchange-related changes infair value of a fixed maturity bond. Using fair value hedge accounting, the swap contract fair value is reported in other long-term investments or accounts payable, accrued expenses and other liabilities. Changes in the fair value of the swap contract, as well as changes in the fair value of the hedged bond attributable to the hedged risk are reported in other realized investment gains and losses.

Under the terms of these various contracts, the Company periodically exchanges cash flows between variable and fixed interest rates or between two currencies for both principal and interest. Foreign currency and combination swaps are primarily Euros,Canadian dollarsand Japanese yen and have terms for periods of up to seven years. Net interest cash flows are reported in operating activities.

The notional values of cash flow hedge swaps were $65 million as of September 30, 2016 and $131 million as of December 31, 2015.The notional value of the fair value hedge swap entered into beginning in the second quarter of 2016 was $23 million as of September 30, 2016.

The effects of these derivative instruments on the Consolidated Financial Statementswere not material as of September 30, 2016 and December 31, 2015, and for the three months and nine months ended September 30, 2016 and 2015.No material amounts were excluded from the assessment of hedge effectiveness and no significant gains or losses were recognized due to hedge ineffectiveness.

Investment Economic Hedges

During the third quarter of 2016, the Company entered into a foreign currency forward contract to hedge the foreign exchange related changes in fair value of U.S. dollar-denominated fixed maturity bonds back to the local currency for one of its foreign subsidiaries. This arrangement was not designated as an accounting hedge, and therefore the forward contract fair value is reported in short-term investments or accounts payable, accrued expenses, and other liabilities, and changes in fair value are reported in other realized investment gains and losses.

Under the terms of this contract, the Company agrees to purchase South Korean won in exchange for U.S. dollars at a future date, generally within three months from the contract's trade date. Cash flows on foreign currency forward contracts are reported in operating activities.

The notional value of the forward contract entered into during the third quarter of 2016 was $50 million as of September 30, 2016.

The effects of these derivative instruments on the Consolidated Financial Statements were not material as of and for the three months ended September 30, 2016.

Fair Value Hedge of Long-Term Corporate Debt

The Company entered into interest rate swap contracts to convert a portion of the interest rate exposure on its long-term debt from fixed to variable rates to more closely align interest expense with interest income received on its cash equivalent and short-term investment balances. The variable rates are benchmarked to LIBOR.

Using fair value hedge accounting, the fair values of the swap contracts are reported in other assets, including other intangibles, or accounts payable, accrued expenses and other liabilities. As the critical terms of these swaps match those of the long-term debt being hedged, the carrying value of the hedged debt is adjusted to reflect changes in its fair value driven by LIBOR. The effects of those adjustments on other operating expenses are offset by the effects of corresponding changes in the swaps' fair value, including interest expense for the difference between the variable and fixed interest rates.

Under the terms of these contracts, the Company provides upfront margin and settles fair value changes and net interest between variable and fixed interest rates daily with a central clearinghouse. Net interest cash flows are reported in operating activities.

The notional values of these derivative instruments were $750 million as of September 30, 2016 and December 31, 2015.

The effects of these derivative instruments on the Consolidated Financial Statements were not material as of September 30, 2016 and December 31, 2015, and for the three and nine months ended September 30, 2016 and 2015.

GMIB

The Company's run-off reinsurance business has written reinsurance contracts with issuers of variable annuities that provide annuitants with certain guarantees of minimum income benefits resulting from the level of variable annuity account values compared with a contractually guaranteed amount (“GMIB liabilities”). According to the contractual terms of the written reinsurance contracts, payment by the Company depends on the actual account value in the underlying mutual funds and the level of interest rates when the contractholders elect to receive minimum income payments. The Company has purchased retrocessional coverage (“GMIB assets”) for these contracts, including the agreement with Berkshire in 2013, effectively exiting this business. See Note 6 for further details.

The fair value effects of GMIB contracts on the financial statements are included in Note 7 and their volume of activity is included in Note 16.Cash flows on these contracts are reported in operating activities.