Derivatives and Hedging Activities

Derivative instruments enable the Company to manage its exposure to various market risks. The value of such instruments is derived from an underlying variable or multiple variables, including equity and interest rate indices or prices. The Company primarily enters into derivative agreements for risk management purposes related to the Company’s products and operations.

The Company’s freestanding derivatives are recorded at fair value and are reflected in other assets or other liabilities. The Company’s freestanding derivative instruments are all subject to master netting arrangements. The Company’s policy on the recognition of derivatives on the Consolidated Balance Sheets is to not offset fair value amounts recognized for derivatives and collateral arrangements executed with the same counterparty under the same master netting arrangement. See Note 12 for additional information regarding the estimated fair value of the Company’s freestanding derivatives after considering the effect of master netting arrangements and collateral.

The Company currently uses derivatives as economic hedges and accounting hedges. The following table presents the balance sheet location and the gross fair value of derivative instruments, including embedded derivatives:



		Assets					Liabilities
Derivatives not designated as hedging instruments	Balance Sheet Location	June 30, 2014		December 31, 2013		Balance Sheet Location	June 30, 2014			December 31, 2013
		(in millions)					(in millions)
GMWB and GMAB
Interest rate contracts	Other assets	$	1,585	$	1,484	Other liabilities	$	1,306		$	1,672
Equity contracts	Other assets	1,642		1,741		Other liabilities	2,767			2,918
Credit contracts	Other assets	—		3		Other liabilities	—			—
Foreign exchange contracts	Other assets	2		2		Other liabilities	—			—
Embedded derivatives⁽¹⁾	N/A	—		—		Policyholder account balances, future policy benefits and claims⁽²⁾	(347		)	(575		)
Total GMWB and GMAB		3,229		3,230			3,726			4,015
Other derivatives:
Equity
EIA embedded derivatives	N/A	—		—		Policyholder account balances, future policy benefits and claims	5			5
IUL	Other assets	33		27		Other liabilities	11			13
IUL embedded derivatives	N/A	—		—		Policyholder account balances, future policy benefits and claims	184			125
Other
Macro hedge program	Other assets	1		4		Other liabilities	13			29
Total other		34		31			213			172
Total derivatives		$	3,263	$	3,261		$	3,939		$	4,187


N/A	Not applicable.


(1)	The fair values of GMWB and GMAB embedded derivatives fluctuate based on changes in equity, interest rate and credit markets.


(2)	The fair value of the GMWB and GMAB embedded derivatives was a net asset at June 30, 2014 and December 31, 2013 and the amount is reported as a contra liability.

See Note 11 for additional information regarding the Company’s fair value measurement of derivative instruments.

The following table presents a summary of the impact of derivatives not designated as hedging instruments on the Consolidated Statements of Income:



		Amount of Gain (Loss) on Derivatives Recognized in Income
Derivatives not designated as hedging instruments	Location of Gain (Loss) on Derivatives Recognized in Income	Three Months Ended June 30,						Six Months Ended June 30,
Derivatives not designated as hedging instruments	Location of Gain (Loss) on Derivatives Recognized in Income	2014			2013			2014			2013
		(in millions)
GMWB and GMAB
Interest rate contracts	Benefits, claims, losses and settlement expenses	$	245		$	(380	)	$	509		$	(512	)
Equity contracts	Benefits, claims, losses and settlement expenses	(197		)	12			(387		)	(480		)
Credit contracts	Benefits, claims, losses and settlement expenses	(12		)	8			(22		)	8
Foreign exchange contracts	Benefits, claims, losses and settlement expenses	—			2			(1		)	7
Embedded derivatives⁽¹⁾	Benefits, claims, losses and settlement expenses	(124		)	255			(228		)	822
Total GMWB and GMAB		(88		)	(103		)	(129		)	(155		)
Other derivatives:
Interest rate
Tax hedge	Net investment income	—			—			3			—
Equity
EIA	Interest credited to fixed accounts	1			—			1			1
EIA embedded derivatives	Interest credited to fixed accounts	(1		)	—			(1		)	(1		)
IUL	Interest credited to fixed accounts	6			2			11			6
IUL embedded derivatives	Interest credited to fixed accounts	5			2			11			5
Other
Macro hedge program	Benefits, claims, losses and settlement expenses	(10		)	—			3			—
Total other		1			4			28			11
Total derivatives		$	(87	)	$	(99	)	$	(101	)	$	(144	)


(1)	The fair values of GMWB and GMAB embedded derivatives fluctuate based on changes in equity, interest rate and credit markets.

The Company holds derivative instruments that either do not qualify or are not designated for hedge accounting treatment. These derivative instruments are used as economic hedges of equity, interest rate, credit and foreign currency exchange rate risk related to various products and transactions of the Company.

Certain annuity contracts contain GMWB or GMAB provisions, which guarantee the right to make limited partial withdrawals each contract year regardless of the volatility inherent in the underlying investments or guarantee a minimum accumulation value of consideration received at the beginning of the contract period, after a specified holding period, respectively. The Company economically hedges the exposure related to non-life contingent GMWB and GMAB provisions primarily using various futures, options, interest rate swaptions, interest rate swaps, total return swaps and variance swaps. At June 30, 2014 and December 31, 2013, the gross notional amount of derivative contracts for the Company’s GMWB and GMAB provisions was $133.0 billion and $142.4 billion, respectively.

The deferred premium associated with certain of the above options is paid or received semi-annually over the life of the option contract or at maturity. The following is a summary of the payments the Company is scheduled to make and receive for these options:



	Premiums Payable		Premiums Receivable
	(in millions)
2014⁽¹⁾	$	185	$	56
2015	355		67
2016	313		54
2017	242		53
2018	194		56
2019-2026	512		82
Total	$	1,801	$	368


(1)	2014 amounts represent the amounts payable and receivable for the period from July 1, 2014 to December 31, 2014.

Actual timing and payment amounts may differ due to future contract settlements, modifications or exercises of options prior to the full premium being paid or received.

During 2013, the Company transferred net derivative liabilities with a fair value of $94 million, consisting of long-dated options, along with cash payment of the same amount to Ameriprise Financial. The transaction improves the risk management profile of statutory tail scenario risk for the Company’s variable annuities.

The Company has a macro hedge program to provide protection against the statutory tail scenario risk arising from variable annuity reserves on its statutory surplus and to cover some of the residual risks not covered by other hedging activities. As a means of economically hedging these risks, the Company uses a combination of options and/or swaps. Certain of the macro hedge derivatives used contain settlement provisions linked to both equity returns and interest rates; the remaining are interest rate contracts or equity contracts. The gross notional amount of these derivative contracts was $829 million and $710 million at June 30, 2014 and December 31, 2013, respectively.

EIA and IUL products have returns tied to the performance of equity markets. As a result of fluctuations in equity markets, the obligation incurred by the Company related to EIA and IUL products will positively or negatively impact earnings over the life of these products. As a means of economically hedging its obligations under the provisions of these products, the Company enters into index options and futures contracts. The gross notional amount of these derivative contracts was $702 million and $512 million at June 30, 2014 and December 31, 2013, respectively.

Embedded Derivatives

Certain annuities contain GMAB and non-life contingent GMWB provisions, which are considered embedded derivatives. In addition, the equity component of the EIA and IUL product obligations are also considered embedded derivatives. These embedded derivatives are bifurcated from their host contracts for valuation purposes and reported on the Consolidated Balance Sheets at fair value with changes in fair value reported in earnings. As discussed above, the Company uses derivatives to mitigate the financial statement impact of these embedded derivatives.

Cash Flow Hedges

The Company has amounts classified in accumulated other comprehensive income (“AOCI”) related to gains and losses associated with the effective portion of previously designated cash flow hedges. The Company reclassifies these amounts into income as the forecasted transactions impact earnings. During the six months ended June 30, 2014, the Company held no derivatives that were designated as cash flow hedges.

At June 30, 2014, the Company expects to reclassify $6 million of deferred loss on derivative instruments from AOCI to earnings during the next 12 months that will be recorded in net investment income. These were originally losses on derivative instruments related to interest rate swaptions. During the six months ended June 30, 2014 and 2013, no hedge relationships were discontinued due to forecasted transactions no longer being expected to occur according to the original hedge strategy. For the six months ended June 30, 2014 and 2013, amounts recognized in earnings on derivative transactions that were ineffective were not material.

The following table presents a rollforward of unrealized derivative losses related to cash flow hedges included in accumulated other comprehensive income (loss):



	2014			2013
	(in millions)
Net unrealized derivative losses at January 1	$	(17	)	$	(21	)
Reclassification of realized losses⁽¹⁾	3			4
Income tax benefit	(1		)	(1		)
Net unrealized derivative losses at June 30	$	(15	)	$	(18	)


(1)	Loss reclassified from AOCI to net investment income on the Consolidated Statements of Income.

Currently, the longest period of time over which the Company is hedging exposure to the variability in future cash flows is five years and relates to interest credited on forecasted fixed premium product sales.

Credit Risk

Credit risk associated with the Company’s derivatives is the risk that a derivative counterparty will not perform in accordance with the terms of the applicable derivative contract. To mitigate such risk, the Company has established guidelines and oversight of credit risk through a comprehensive enterprise risk management program that includes members of senior management. Key components of this program are to require preapproval of counterparties and the use of master netting arrangements and collateral arrangements whenever practical. See Note 12 for additional information on the Company’s credit exposure related to derivative assets.

Certain of the Company’s derivative contracts contain provisions that adjust the level of collateral the Company is required to post based on the Company’s financial strength rating (or based on the debt rating of the Company’s parent, Ameriprise Financial). Additionally, certain of the Company’s derivative contracts contain provisions that allow the counterparty to terminate the contract if the Company does not maintain a specific financial strength rating or Ameriprise Financial’s debt does not maintain a specific credit rating (generally an investment grade rating). If these termination provisions were to be triggered, the Company’s counterparty could require immediate settlement of any net liability position. At June 30, 2014 and December 31, 2013, the aggregate fair value of derivative contracts in a net liability position containing such credit contingent provisions was $739 million and $950 million, respectively. The aggregate fair value of assets posted as collateral for such instruments as of June 30, 2014 and December 31, 2013 was $739 million and $940 million, respectively. If the credit contingent provisions of derivative contracts in a net liability position at June 30, 2014 and December 31, 2013 were triggered, the aggregate fair value of additional assets that would be required to be posted as collateral or needed to settle the instruments immediately would have been nil and $10 million, respectively.