DERIVATIVE INSTRUMENTS

Types of Derivative Instruments and Derivative Strategies

The Company utilizes various derivative instruments and strategies to manage its risk. Commonly used derivative instruments include, but are not necessarily limited to:

•Interest rate contracts: futures, swaps, options, swaptions, caps and floors

•Equity contracts: futures, options and total return swaps

•Foreign exchange contracts: futures, options, forwards and swaps

•Credit contracts: single and index reference credit default swaps

•Other contracts: embedded derivatives

For detailed information on these contracts and the related strategies, see Note 10 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Primary Risks Managed by Derivatives

The table below provides a summary of the gross notional amount and fair value of derivative contracts by the primary underlying risks, excluding embedded derivatives and associated reinsurance recoverables. Many derivative instruments contain multiple underlying risks. The fair value amounts below represent the gross fair value of derivative contracts prior to taking into account the netting effects of master netting agreements, cash collateral, and NPR.



	September 30, 2018							December 31, 2017
Primary Underlying Risk/Instrument Type			Gross Fair Value							Gross Fair Value
Primary Underlying Risk/Instrument Type	Notional		Assets		Liabilities			Notional		Assets		Liabilities
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Currency/Interest Rate
Foreign Currency Swaps	$	713,959	$	23,729	$	(34,753	)	$	649,905	$	18,243	$	(44,806	)
Total Qualifying Hedges	$	713,959	$	23,729	$	(34,753	)	$	649,905	$	18,243	$	(44,806	)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate
Interest Rate Swaps	$	246,925	$	11,301	$	(6,463	)	$	246,925	$	23,032	$	0
Foreign Currency
Foreign Currency Forwards	21,456		189		(13		)	16,320		0		(376		)
Credit
Credit Default Swaps	756		0		(18		)	1,594		0		(96		)
Currency/Interest Rate
Foreign Currency Swaps	87,548		4,288		(4,836		)	95,145		4,347		(5,600		)
Equity
Equity Options	1,758,194		80,710		(22,272		)	1,277,102		69,472		(23,500		)
Total Non-Qualifying Hedges	$	2,114,879	$	96,488	$	(33,602	)	$	1,637,086	$	96,851	$	(29,572	)
Total Derivatives (1)	$	2,828,838	$	120,217	$	(68,355	)	$	2,286,991	$	115,094	$	(74,378	)


(1)	Excludes embedded derivatives and associated reinsurance recoverables which contain multiple underlying risks.

The fair value of the embedded derivatives, included in "Future policy benefits," was a net liability of $2,908 million and $5,453 million as of September 30, 2018 and December 31, 2017, respectively. The fair value of the related reinsurance recoverables, included in "Reinsurance recoverables" or "Other liabilities," was a net asset of $2,917 million and $5,458 million as of September 30, 2018 and December 31, 2017, respectively. Of these reinsurance recoverables, the fair value related to the living benefits guarantee from PALAC and Prudential Insurance was a net asset of $2,958 million and $5,445 million and the fair value related to the Prudential Premier® Retirement Variable Annuity with Highest Daily Lifetime Income ("HDI") v.3.0 from Union Hamilton Reinsurance, Ltd. ("Union Hamilton"), an external counterparty, was a net liability of $41 million and a net asset of $13 million as of September 30, 2018 and December 31, 2017, respectively. See Note 7 for additional information on these reinsurance agreements.

The fair value of the embedded derivatives, included in "Policyholders' account balances," was a net liability of $61 million and $47 million as of September 30, 2018 and December 31, 2017, respectively. There were no related reinsurance recoverables at each respective period.

Offsetting Assets and Liabilities

The following table presents recognized derivative instruments (excluding embedded derivatives and associated reinsurance recoverables), and repurchase and reverse repurchase agreements that are offset in the Unaudited Interim Consolidated Statements of Financial Position, and/or are subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in the Unaudited Interim Consolidated Statements of Financial Position.



	September 30, 2018
	Gross Amounts of Recognized Financial Instruments		Gross Amounts Offset in the Consolidated Statements of Financial Position			Net Amounts Presented in the Consolidated Statements of Financial Position		Financial Instruments/ Collateral (1)			Net Amount
	(in thousands)
Offsetting of Financial Assets:
Derivatives (1)	$	120,214	$	(112,098	)	$	8,116	$	(5,961	)	$	2,155
Securities purchased under agreements to resell	205,000		0			205,000		(205,000		)	0
Total Assets	$	325,214	$	(112,098	)	$	213,116	$	(210,961	)	$	2,155
Offsetting of Financial Liabilities:
Derivatives (1)	$	68,355	$	(68,355	)	$	0	$	0		$	0
Securities sold under agreements to repurchase	0		0			0		0			0
Total Liabilities	$	68,355	$	(68,355	)	$	0	$	0		$	0



	December 31, 2017
	Gross Amounts of Recognized Financial Instruments		Gross Amounts Offset in the Consolidated Statements of Financial Position			Net Amounts Presented in the Consolidated Statements of Financial Position		Financial Instruments/ Collateral (1)			Net Amount
	(in thousands)
Offsetting of Financial Assets:
Derivatives (1)	$	115,086	$	(115,086	)	$	0	$	0		$	0
Securities purchased under agreements to resell	148,000		0			148,000		(148,000		)	0
Total Assets	$	263,086	$	(115,086	)	$	148,000	$	(148,000	)	$	0
Offsetting of Financial Liabilities:
Derivatives (1)	$	74,378	$	(69,718	)	$	4,660	$	(245	)	$	4,415
Securities sold under agreements to repurchase	0		0			0		0			0
Total Liabilities	$	74,378	$	(69,718	)	$	4,660	$	(245	)	$	4,415


(1)	Amounts exclude the excess of collateral received/pledged from/to the counterparty.

For information regarding the rights of offset associated with the derivative assets and liabilities in the table above see “Credit Risk” below and Note 9. For securities purchased under agreements to resell and securities sold under agreements to repurchase, the Company monitors the value of the securities and maintains collateral, as appropriate, to protect against credit exposure. Where the Company has entered into repurchase and resale agreements with the same counterparty, in the event of default, the Company would generally be permitted to exercise rights of offset. For additional information on the Company’s accounting policy for securities repurchase and resale agreements, see Note 2 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Cash Flow Hedges

The primary derivative instruments used by the Company in its cash flow hedge accounting relationships are currency swaps. These instruments are only designated for hedge accounting in instances where the appropriate criteria are met. The Company does not use futures, options, credit, equity or embedded derivatives in any of its cash flow hedge accounting relationships.

The following tables provide the financial statement classification and impact of derivatives used in qualifying and non-qualifying hedge relationships, excluding the offset of the hedged item in an effective hedge relationship.



	Three Months Ended September 30, 2018
	Realized Investment Gains (Losses)			Net Investment Income		Other Income		AOCI (1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	1,767	$	1,872	$	1,454
Total cash flow hedges	0			1,767		1,872		1,454
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(4,543		)	0		0		0
Currency	230			0		0		0
Currency/Interest Rate	(693		)	0		18		0
Credit	0			0		0		0
Equity	20,901			0		0		0
Embedded Derivatives	(64,288		)	0		0		0
Total non-qualifying hedges	(48,393		)	0		18		0
Total	$	(48,393	)	$	1,767	$	1,890	$	1,454



	Nine Months Ended September 30, 2018
	Realized Investment Gains (Losses)			Net Investment Income		Other Income		AOCI (1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	4,916	$	6,917	$	10,111
Total cash flow hedges	0			4,916		6,917		10,111
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(17,068		)	0		0		0
Currency	895			0		0		0
Currency/Interest Rate	383			0		33		0
Credit	(2		)	0		0		0
Equity	23,725			0		0		0
Embedded Derivatives	(138,967		)	0		0		0
Total non-qualifying hedges	(131,034		)	0		33		0
Total	$	(131,034	)	$	4,916	$	6,950	$	10,111



	Three Months Ended September 30, 2017
	Realized Investment Gains (Losses)			Net Investment Income		Other Income			AOCI (1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	1,705	$	(3,013	)	$	(17,210	)
Total cash flow hedges	0			1,705		(3,013		)	(17,210		)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(2,160		)	0		0			0
Currency	(537		)	0		0			0
Currency/Interest Rate	(5,665		)	0		(28		)	0
Credit	(7		)	0		0			0
Equity	7,574			0		0			0
Embedded Derivatives	(303,055		)	0		0			0
Total non-qualifying hedges	(303,850		)	0		(28		)	0
Total	$	(303,850	)	$	1,705	$	(3,041	)	$	(17,210	)



	Nine Months Ended September 30, 2017
	Realized Investment Gains (Losses)			Net Investment Income		Other Income			AOCI (1)
	(in thousands)
Derivatives Designated as Hedge Accounting Instruments:
Cash flow hedges
Currency/Interest Rate	$	0		$	4,473	$	(7,805	)	$	(39,924	)
Total cash flow hedges	0			4,473		(7,805		)	(39,924		)
Derivatives Not Qualifying as Hedge Accounting Instruments:
Interest Rate	(528		)	0		0			0
Currency	(1,245		)	0		0			0
Currency/Interest Rate	(4,607		)	0		(51		)	0
Credit	(44		)	0		0			0
Equity	18,016			0		0			0
Embedded Derivatives	(70,911		)	0		0			0
Total non-qualifying hedges	(59,319		)	0		(51		)	0
Total	$	(59,319	)	$	4,473	$	(7,856	)	$	(39,924	)


(1)	Amounts deferred in AOCI.

For the nine months ended September 30, 2018 and 2017, the ineffective portion of derivatives accounted for using hedge accounting was de minimis to the Company’s results of operations. Also, there were no material amounts reclassified into earnings relating to instances in which the Company discontinued cash flow hedge accounting because the forecasted transaction did not occur by the anticipated date or within the additional time period permitted by the authoritative guidance for the accounting for derivatives and hedging.

Presented below is a rollforward of current period cash flow hedges in AOCI before taxes:



	(in thousands)
Balance, December 31, 2017	$	(17,678	)
Net deferred gains (losses) on cash flow hedges from January 1 to September 30, 2018	20,554
Amount reclassified into current period earnings	(10,443		)
Balance, September 30, 2018	$	(7,567	)

The changes in fair value of cash flow hedges are deferred in AOCI and are included in "Net unrealized investment gains (losses)" in the Unaudited Interim Consolidated Statements of Operations and Comprehensive Income (Loss); these amounts are then reclassified to earnings when the hedged item affects earnings. Using September 30, 2018 values, it is estimated that a pre-tax gain of $6 million will be reclassified from AOCI to earnings during the subsequent twelve months ending September 30, 2019, offset by amounts pertaining to the hedged items.

The exposures the Company is hedging with these qualifying cash flow hedges include the variability of the payment or receipt of interest or foreign currency amounts on existing financial instruments.

Credit Derivatives

The Company has no exposure from credit derivative positions where it has written credit protection as of September 30, 2018 and December 31, 2017.

The Company has purchased credit protection using credit derivatives in order to hedge specific credit exposures in the Company’s investment portfolio. The Company has outstanding notional amounts of $1 million and $2 million reported at fair value as a liability of $0.0 million and $0.1 million as of September 30, 2018 and December 31, 2017, respectively.

Credit Risk

The Company is exposed to credit-related losses in the event of non-performance by counterparty to financial derivative transactions with a positive fair value. The Company manages credit risk by entering into derivative transactions with its affiliate, Prudential Global Funding LLC (“PGF”), related to its over-the-counter ("OTC") derivatives. PGF, in turn, manages its credit risk by: (i) entering into derivative transactions with highly rated major international financial institutions and other creditworthy counterparties governed by master netting agreement, as applicable; (ii) trading through central clearing and OTC parties; (iii) obtaining collateral, such as cash and securities, when appropriate; and (iv) setting limits on single party credit exposures which are subject to periodic management review.

Substantially all of the Company’s derivative agreements have zero thresholds which require daily full collateralization by the party in a liability position.