7. Derivative Financial Instruments

Derivative transactions are generally entered into pursuant to master agreements and other contracts with approved counterparties that provide for a single net payment to be made by one party to the other on a daily basis, periodic payment dates, or at the due date, expiration or termination of the agreement.

Certain derivative master agreements contain provisions that would allow the counterparties to require immediate settlement of all derivative instruments in a net liability position if the Company were to default on any debt obligations over a certain threshold. The aggregate fair value of derivative instruments with credit-risk-related contingent features that were in a net liability position was $156,959 and $55,875 as of September 30, 2013 and December 31, 2012, respectively. The Company had pledged collateral related to these derivatives of $132,180 and $43,360 as of September 30, 2013 and December 31, 2012, respectively, in the normal course of business. If the credit-risk-related contingent features were triggered on September 30, 2013 the fair value of assets that could be required to settle the derivatives in a net liability position was $24,779.

At September 30, 2013 and December 31, 2012, the Company had pledged $132,344 and $54,400, respectively, of unrestricted cash collateral to counterparties in the normal course of business.

Cash flow hedges — Interest rate swap agreements are used to convert the interest rate on certain debt securities from a floating rate to a fixed rate. Cross-currency swaps are used to manage the foreign currency exchange rate risk associated with investments denominated in other than U.S. dollars. Interest rate futures are used to manage the interest rate risks of forecasted acquisitions of fixed rate maturity investments. These derivatives are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities. The Company’s derivatives treated as cash flow hedges are eligible for hedge accounting.

At September 30, 2013, the Company estimated $7,823 of net derivative gains included in AOCI will be reclassified into net income within the next twelve months.

Fair value hedges — Interest rate swap agreements are used to convert the interest rate on certain debt securities from a fixed rate to a floating rate to manage the interest rate risk of the change in the fair value of certain fixed rate maturity investments. Interest rate futures are used to manage the interest rate risk of the change in the fair value of certain fixed rate maturity investments. The Company’s derivatives treated as fair value hedges are eligible for hedge accounting.

Derivatives not designated as hedging instruments

The Company enters into certain transactions in which derivatives are hedging an economic risk but hedge accounting is not elected. These derivative instruments include: exchange-traded interest rate swap futures, exchange-traded equity index futures on certain indices, over-the-counter (“OTC”) interest rate swaptions, OTC interest rate swaps, exchange-traded Eurodollar interest rate futures and treasury interest rate futures. Certain of the Company’s OTC derivatives are cleared and settled through a central clearing counterparty while others are bilateral contracts between the Company and a counterparty.

The derivative instruments mentioned above are economic hedges and used to manage risk. These transactions are used to offset changes in liabilities, hedge the economic effect of a large increase in interest rates, manage the potential variability in future interest payments due to a change in credited interest rates and the related change in cash flows due to increased surrenders, manage interest rate risks of forecasted acquisitions of fixed rate maturity investments and forecasted liability pricing, and hedge equity-based fee income.

The Company uses TBA forward contracts to gain exposure to the investment risk and return of agency mortgage-backed securities (pass-throughs). These transactions enhance the return on the Company’s investment portfolio and provide a more liquid and cost effective method of achieving these goals than purchasing or selling individual agency mortgage-backed pools. As the Company does not regularly accept delivery of such securities, they are accounted for as derivatives. These transactions are disclosed as Other forward contracts in the following tables.

The following tables summarize derivative financial instruments:

	September 30, 2013
			Net derivatives			Asset derivatives		Liability derivatives
	Notional amount		Fair value			Fair value (1)		Fair value (1)
Hedge designation/derivative type:
Derivatives designated as hedges:
Cash flow hedges:
Interest rate swaps	$	193,700	$	16,663		$	16,663	$	—
Cross-currency swaps	634,717		(151,071		)	3,145		154,216
Total cash flow hedges	828,417		(134,408		)	19,808		154,216

Fair value hedges:
Interest rate swaps	78,000		3,932			4,114		182
Total fair value hedges	78,000		3,932			4,114		182

Total derivatives designated as hedges	906,417		(130,476		)	23,922		154,398

Derivatives not designated as hedges:
Interest rate swaps	42,100		(1,607		)	955		2,562
Futures on equity indices	4,074		—			—		—
Interest rate futures	16,080		—			—		—
Interest rate swaptions	544,674		920			920		—
Other forward contracts	5,762,300		55,530			85,479		29,949

Total derivatives not designated as hedges	6,369,228		54,843			87,354		32,511

Total cash flow hedges, fair value hedges and derivatives not designated as hedges	$	7,275,645	$	(75,633	)	$	111,276	$	186,909

(1) The estimated fair value of all derivatives in an asset position is reported within other assets and the estimated fair value of all derivatives in a liability position is reported within other liabilities in the condensed consolidated balance sheets.

	December 31, 2012
			Net derivatives			Asset derivatives		Liability derivatives
	Notional amount		Fair value			Fair value (1)		Fair value (1)
Hedge designation/derivative type:
Derivatives designated as hedges:
Cash flow hedges:
Interest rate swaps	$	184,200	$	26,113		$	26,113	$	—
Cross-currency swaps	424,248		(81,109		)	4,643		85,752
Total cash flow hedges	608,448		(54,996		)	30,756		85,752

Fair value hedges:
Interest rate swaps	183,776		(1,391		)	258		1,649
Total fair value hedges	183,776		(1,391		)	258		1,649

Total derivatives designated as hedges	792,224		(56,387		)	31,014		87,401

Derivatives not designated as hedges:
Interest rate swaps	29,264		305			1,062		757
Futures on equity indices	3,133		—			—		—
Interest rate futures	80,550		—			—		—
Interest rate swaptions	688,674		342			342		—

Total derivatives not designated as hedges	801,621		647			1,404		757

Total cash flow hedges, fair value hedges and derivatives not designated as hedges	$	1,593,845	$	(55,740	)	$	32,418	$	88,158

Notional amounts are used to express the extent of the Company’s involvement in derivative transactions and represent a standard measurement of the volume of its derivative activity. Notional amounts represent those amounts used to calculate contractual flows to be exchanged and are not paid or received.

The Company had 44 and 75 interest rate swap transactions with an average notional amount of $3,228 and $8,685 during the nine months ended September 30, 2013 and the year ended December 31, 2012, respectively. During the nine months ended September 30, 2013 and the year ended December 31, 2012, the Company had 15 and 23 cross-currency swap transactions with an average notional amount of $14,031 and $12,710, respectively. The Company had 503 and 931 futures transactions with an average number of contracts per transaction of 9 and 11 during the nine months ended September 30, 2013 and the year ended December 31, 2012, respectively. The Company had 39 and 46 swaption transactions with an average notional amount of $5,077 and $5,528 during the nine months ended September 30, 2013 and the year ended December 31, 2012, respectively. The Company had 869 and 737 TBA forward transactions with an average notional amount of $47,714 and $33,237 during the nine months ended September 30, 2013 and the year ended December 31, 2012, respectively.

Significant changes in the derivative notional amount during the nine months ended September 30, 2013 were primarily due to the following:

· The net decrease of $290,969 in interest rate swaps, interest rate swaptions and futures was primarily due to (i) a change in the Company’s interest rate risk hedging strategy and (ii) the closing of fair value hedges associated with the concurrent sales of certain fixed rate maturity investments.

· The increase of $210,469 in cross-currency swaps was due to additional swaps opened to hedge newly purchased assets denominated in British pounds and Euros.

· The increase of $5,762,300 in other forward contracts since December 31, 2012 was due to the Company’s positions being closed at year end.

The Company recognized total derivative gains (losses) in net investment income of $87,137 and $14,100 for the three-month periods ended September 30, 2013 and 2012, respectively. The Company recognized total derivative gains (losses) in net investment income of $60,882 and $27,243 for the nine-month periods ended September 30, 2013 and 2012, respectively. The Company recognized net investment gains (losses) on closed derivative positions of ($67,117) and $13,046 for the three-month periods ended September 30, 2013 and 2012, respectively. The Company recognized net investment gains (losses) on closed derivative positions of ($103,440) and $24,727 for the nine-month periods ended September 30, 2013 and 2012, respectively. The preceding amounts are shown net of any gains (losses) on the hedged assets in a fair value hedge that has been recorded in net investment income.

The following tables present the effect of derivative instruments in the condensed consolidated statements of income reported by cash flow hedges, fair value hedges and economic hedges:

	Gain (loss) recognized
	in OCI on derivatives						Gain (loss) reclassified from OCI
	(Effective portion)						into net income (Effective portion)
	Three months ended September 30,						Three months ended September 30,
	2013			2012			2013		2012
Cash flow hedges:
Interest rate swaps	$	(991	)	$	889		$	575	$	707	(A)
Cross-currency swaps	(48,917		)	(9,467		)	—		—
Interest rate futures	—			—			16		16		(A)
Total cash flow hedges	$	(49,908	)	$	(8,578	)	$	591	$	723

(A) Net investment income.

	Gain (loss) recognized
	in OCI on derivatives						Gain (loss) reclassified from OCI
	(Effective portion)						into net income (Effective portion)
	Nine months ended September 30,						Nine months ended September 30,
	2013			2012			2013		2012
Cash flow hedges:
Interest rate swaps	$	(10,792	)	$	7,095		$	4,491	$	2,149	(A)
Cross-currency swaps	(22,208		)	(8,634		)	—		—
Interest rate futures	—			—			48		48		(A)
Total cash flow hedges	$	(33,000	)	$	(1,539	)	$	4,539	$	2,197

(A) Net investment income.

	Gain (loss) on derivatives						Gain (loss) on hedged assets
	recognized in net income						recognized in net income
	Three months ended September 30,						Three months ended September 30,
	2013			2012			2013			2012
Fair value hedges:
Interest rate swaps	$	(1,756	)	$	(69	)(A)	$	—		$	—
Interest rate swaps	2,094			—		(B)	—			—
Items hedged in interest rate swaps	—			—			1,768			69		(A)
Items hedged in interest rate swaps	—			—			(2,106		)	—		(B)
Total fair value hedges	$	338		$	(69	)	$	(338	)	$	69

(A) Net investment income.

(B) Represents realized gains (losses) on closed positions recorded in realized investment gains (losses), net.

	Gain (loss) on derivatives					Gain (loss) on hedged assets
	recognized in net income					recognized in net income
	Nine months ended September 30,					Nine months ended September 30,
	2013		2012			2013			2012
Fair value hedges:
Interest rate swaps	$	5,324	$	(762	)(A)	$	—		$	—
Interest rate swaps	1,909		—		(B)	—			—
Items hedged in interest rate swaps	—		—			(4,290		)	762		(A)
Items hedged in interest rate swaps	—		—			(2,943		)	—		(B)
Total fair value hedges	$	7,233	$	(762	)	$	(7,233	)	$	762

(A) Net investment income.

(B) Represents realized gains (losses) on closed positions recorded in realized investment gains (losses), net.

	Gain (loss) on derivatives recognized in net income
	Three months ended September 30,
	2013			2012
Derivatives not designated as hedging instruments:
Futures on equity indices	$	(25	)(A)	$	(4	)(A)
Futures on equity indices	(330		)(B)	(1,077		)(B)
Interest rate swaps	(597		)(A)	(267		)(A)
Interest rate swaps	14		(B)	—		(B)
Interest rate futures	(143		)(A)	(547		)(A)
Interest rate futures	39		(B)	(306		)(B)
Interest rate swaptions	709		(A)	124		(A)
Interest rate swaptions	(735		)(B)	(495		)(B)
Other forward contracts	86,590		(A)	14,071		(A)
Other forward contracts	(66,093		)(B)	14,924		(B)

Total derivatives not designated as hedging instruments	$	19,429		$	26,423

(A) Net investment income.

(B) Represents realized gains (losses) on closed positions recorded in realized investment gains (losses), net.

	Gain (loss) on derivatives recognized in net income
	Nine months ended September 30,
	2013			2012
Derivatives not designated as hedging instruments:
Futures on equity indices	$	61	(A)	$	75	(A)
Futures on equity indices	(1,442		)(B)	(1,299		)(B)
Interest rate swaps	(1,912		)(A)	8,611		(A)
Interest rate swaps	(622		)(B)	(4,432		)(B)
Interest rate futures	(663		)(A)	(831		)(A)
Interest rate futures	529		(B)	(1,843		)(B)
Interest rate swaptions	2,293		(A)	358		(A)
Interest rate swaptions	(2,043		)(B)	(1,265		)(B)
Other forward contracts	55,530		(A)	16,833		(A)
Other forward contracts	(98,828		)(B)	33,566		(B)

Total derivatives not designated as hedging instruments	$	(47,097	)	$	49,773

(A) Net investment income.

(B) Represents realized gains (losses) on closed positions recorded in realized investment gains (losses), net.