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Derivative Financial Instruments
 9 Months Ended
Sep. 30, 2012
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments
Derivative Financial Instruments

The Company enters into the following types of derivatives:

Interest rate swaps: Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and/or liabilities. Using interest rate swaps, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest payments, calculated by reference to an agreed upon notional principal amount. These transactions are entered into pursuant to master agreements that provide for a single net payment to be made to/from the counterparty at each due date. The Company utilizes these contracts in non-qualifying hedging relationships.

Foreign exchange swaps: The Company uses foreign exchange or currency swaps to reduce the risk of change in the value, yield or cash flows associated with certain foreign denominated invested assets. Foreign exchange swaps represent contracts that require the exchange of foreign currency cash flows against U.S. dollar cash flows at regular periods, typically quarterly or semi-annually. The Company utilizes these contracts in non-qualifying hedging relationships.

Credit default swaps: Credit default swaps are used to reduce credit loss exposure with respect to certain assets that the Company owns, or to assume credit exposure on certain assets that the Company does not own. Payments are made to or received from the counterparty at specified intervals. In the event of a default on the underlying credit exposure, the Company will either receive a payment (purchased credit protection) or will be required to make a payment (sold credit protection) equal to the par minus recovery value of the swap contract. The Company utilizes these contracts in non-qualifying hedging relationships.

Total return swaps: The Company uses total return swaps as a hedge against a decrease in variable annuity account values, which are invested in certain indices. Using total return swaps, the Company agrees with another party to exchange, at specified intervals, the difference between the economic risk and reward of assets or a market index and the LIBOR rate, calculated by reference to an agreed upon notional principal amount. No cash is exchanged at the onset of the contracts. Cash is paid and received over the life of the contract based upon the terms of the swaps. The Company utilizes these contracts in non-qualifying hedging relationships.

Currency forwards: The Company uses currency forward contracts to hedge policyholder liabilities associated with the variable annuity contracts which are linked to foreign indices. The currency fluctuations may result in a decrease in account values, which would increase the possibility of the Company incurring an expense for guaranteed benefits in excess of account values. The Company utilizes these contracts in non-qualifying hedging relationships.

Forwards: The Company uses forward contracts to hedge certain invested assets against movement in interest rates, particularly mortgage rates. The Company uses To Be Announced securities as an economic hedge against rate movements. Forward contracts are utilized in non-qualifying hedging relationships.

Futures: Futures contracts are used to hedge against a decrease in certain equity indices. Such decreases may result in a decrease in variable annuity account values which would increase the possibility of the Company incurring an expense for guaranteed benefits in excess of account values. The Company also uses futures contracts as a hedge against an increase in certain equity indices. Such increases may result in increased payments to the holders of the fixed index annuity contracts. The Company enters into exchange traded futures with regulated futures commissions that are members of the exchange. The Company also posts initial and variation margin with the exchange on a daily basis. The Company utilizes exchange-traded futures in non-qualifying hedging relationships.

Swaptions: A swaption is an option to enter into a swap with a forward starting effective date. The Company uses swaptions to
hedge the interest rate exposure associated with the minimum crediting rate and book value guarantees embedded in the retirement products that the Company offers. Increases in interest rates will generate losses on assets that are backing such liabilities. In certain instances, the Company locks in the economic impact of existing purchased swaptions by entering into offsetting written swaptions. Swaptions are also used to hedge against an increase in the interest rate benchmarked crediting strategies within Fixed indexed annuities ("FIA") contracts. Such increases may result in increased payments to contract holders of FIA contracts and the interest rate swaptions offset this increased exposure. The Company pays a premium when it purchases the swaption. The Company utilizes these contracts in non-qualifying hedging relationships.

Options: The Company uses put options to hedge against the decrease in certain equity indices and volatilities associated with those indices. Decreases in equity indices and increases in volatility will result in higher valuations on the economic liabilities associated with variable annuity minimum guaranteed living benefits. The Company also uses call options to hedge against an increase in various equity indices. Such increases may result in increased payments to the holders of the FIA contracts. The Company pays an upfront premium to purchase these options. The Company utilizes these options in non-qualifying hedging relationships.

Variance swaps: The Company uses variance swaps to manage equity volatility risk on the economic liabilities associated with certain minimum guaranteed living benefits. An increase in the equity volatility results in a higher valuations of such liabilities. In an equity variance swap, the Company agrees with another party to exchange amounts in the future, based on the changes in equity volatility over a defined period. Equity variance swaps are utilized in non-qualifying hedging relationships.

Embedded derivatives: The Company also invests in certain fixed maturity instruments and has issued certain annuity products, that contain embedded derivatives whose market value is at least partially determined by, among other things, levels of or changes in domestic and/or foreign interest rates (short-term or long-term), exchange rates, prepayment rates, equity rates, or credit ratings/spreads. Embedded derivatives within fixed maturities are reported with the host contract on the Condensed Balance Sheets, and changes in fair value of the embedded derivatives are recorded in Other net realized capital gains (losses) in the Condensed Statements of Operations. Embedded derivatives within annuity products are included in Future policy benefits and claims reserves on the Condensed Balance Sheets, and changes in the fair value of the embedded derivatives are recorded in Other net realized capital gains (losses) in the Condensed Statements of Operations.

In addition, the Company has entered into two coinsurance with funds withheld arrangements that contain embedded derivatives in which the fair value is based on the change in the fair value of the underlying assets held in trust.  The embedded derivative within the coinsurance funds withheld arrangement is included in Funds held under reinsurance treaties with affiliates on the Condensed Balance Sheets, and changes in the fair value are recorded in Interest credited and other benefits to contract owners in the Condensed Statements of Operations.

The notional amounts and fair values of derivatives were as follows as of September 30, 2012 and December 31, 2011:

 
2012
 
2011 (As revised)
 
Notional
Amount
 
Asset
Fair Value
 
Liability
Fair Value
 
Notional
Amount
 
Asset
Fair Value
 
Liability
Fair Value
Derivatives: Non-qualifying for hedge accounting:
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
$
27,824.8

 
$
1,465.7

 
$
572.6

 
$
27,046.0

 
$
1,538.4

 
$
520.0

Foreign exchange contracts
1,422.8

 
15.0

 
39.7

 
1,297.8

 
9.7

 
42.4

Equity contracts
15,156.8

 
147.6

 
29.5

 
15,434.3

 
60.1

 
28.4

Credit contracts
71.0

 
0.5

 
0.1

 
143.4

 
0.9

 
14.1

Embedded derivatives:
 
 
 
 
 
 
 
 
 
 
 
Within fixed maturity investments
N/A

 
51.1

 
—

 
N/A

 
55.0

 
—

Within annuity products
N/A

 
—

 
3,349.7

 
N/A

 
—

 
3,512.1

Within reinsurance agreements 
N/A

 
—

 
317.7

 
N/A

 
—

 
230.9

Total
 
 
$
1,679.9

 
$
4,309.3

 
 
 
$
1,664.1

 
$
4,347.9

N/A - Not Applicable.


Net realized gains (losses) on derivatives were as follows for the three and nine months ended September 30, 2012 and 2011:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
 
 
(As revised)
 
 
 
(As revised)
Derivatives: Qualifying for hedge accounting(1):
 

 
 

 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
    Interest rate contracts
$
—

 
$
0.3

 
$
—

 
$
—

Fair value hedges:
 
 
 
 
 
 
 
    Interest rate contracts
—

 
—

 
—

 
—

Derivatives: Non-qualifying for hedge accounting(1):
 
 
 
 
 
 
 
Interest rate contracts
$
(27.1
)
 
$
1,054.3

 
$
275.4

 
$
1,173.7

Foreign exchange contracts
(38.1
)
 
56.5

 
(10.1
)
 
(7.5
)
Equity contracts
(709.1
)
 
798.1

 
(1,661.6
)
 
488.0

Credit contracts
0.9

 
(11.4
)
 
0.5

 
(6.5
)
Embedded derivatives:
 

 
 

 
 
 
 
Within fixed maturity investments
(3.0
)
 
8.8

 
(3.9
)
 
9.0

Within annuity products
517.3

 
(861.4
)
 
227.1

 
(977.0
)
Within reinsurance agreements
(48.5
)
 
(213.1
)
 
(86.8
)
 
(239.4
)
Total
$
(307.6
)
 
$
832.1

 
$
(1,259.4
)
 
$
440.3

(1) Changes in value for effective fair value hedges are recorded in Other net realized capital losses. Changes in fair value upon disposal for effective cash flow hedges are recorded in Other net realized capital gains (losses) in the Condensed Statements of Operations.


Credit Default Swaps

The Company has entered into various credit default swaps. When credit default swaps are sold, the Company assumes credit exposure to certain assets that it does not own.  Credit default swaps may also be purchased to reduce credit exposure in the Company’s portfolio. Credit default swaps involve a transfer of credit risk from one party to another in exchange for periodic payments.  These instruments are typically written for a maturity period of five years and do not contain recourse provisions, which would enable the seller to recover from third parties.  The Company has International Swaps and Derivatives Association, Inc. ("ISDA") agreements with each counterparty with which it conducts business and tracks the collateral positions for each counterparty.  To the extent cash collateral is received, it is included in Payables under securities loan agreements, including collateral held, on the Condensed Balance Sheets and is reinvested in short-term investments.  Collateral held is used in accordance with the Credit Support Annex ("CSA") to satisfy any obligations.  Investment grade bonds owned by the Company are the source of noncash collateral posted, which is reported in Securities pledged on the Condensed Balance Sheets.  In the event of a default on the underlying credit exposure, the Company will either receive an additional payment (purchased credit protection) or will be required to make an additional payment (sold credit protection) equal to par value minus recovery value of the swap contract. As of September 30, 2012, the fair value of credit default swaps of $0.5 and $0.1 were included in Derivatives assets and Derivatives liabilities, respectively, on the Condensed Balance Sheets.  As of December 31, 2011, the fair value of credit default swaps of $0.9 and $14.1 were included in Derivatives assets and Derivatives liabilities, respectively, on the Condensed Balance Sheets.  As of September 30, 2012 and December 31, 2011, the maximum potential future net exposure to the Company on the sale of credit default swaps was $70.5 and $108.8, respectively.