Derivative Instruments

Accounting for Derivative Instruments and Hedging Activities

See Note 2 – “Significant Accounting Policies and Pronouncements” of the Company’s 2018 Annual Report for a detailed discussion of the accounting treatment for derivative instruments, including embedded derivatives. See Note 6 – “Fair Value of Assets and Liabilities” for additional disclosures related to the fair value hierarchy for derivative instruments, including embedded derivatives.

Types of Derivatives Used by the Company

The Company utilizes various derivative instruments and strategies to manage its risks. Commonly used derivative instruments include, but are not necessarily limited to: credit default swaps, financial futures, equity options, foreign currency swaps, foreign currency forwards, interest rate swaps, synthetic guaranteed investment contracts (“GICs”), consumer price index (“CPI”) swaps, longevity swaps, mortality swaps and embedded derivatives.

For detailed information on these derivative instruments and the related strategies, see Note 5 – “Derivative Instruments” of the Company’s 2018 Annual Report.

Summary of Derivative Positions

Derivatives, except for embedded derivatives and longevity and mortality swaps, are carried on the Company’s condensed consolidated balance sheets in other invested assets or other liabilities, at fair value. Longevity and mortality swaps are included on the condensed consolidated balance sheets in other assets or other liabilities, at fair value. Embedded derivative assets and liabilities on modified coinsurance (“modco”) or funds withheld arrangements are included on the condensed consolidated balance sheets with the host contract in funds withheld at interest, at fair value. Embedded derivative liabilities on indexed annuity and variable annuity products are included on the condensed consolidated balance sheets with the host contract in interest-sensitive contract liabilities, at fair value. The following table presents the notional amounts and gross fair value of derivative instruments prior to taking into account the netting effects of master netting agreements as of March 31, 2019 and December 31, 2018 (dollars in thousands):



		March 31, 2019						December 31, 2018
	Primary Underlying Risk	Notional		Carrying Value/Fair Value				Notional		Carrying Value/Fair Value
	Primary Underlying Risk	Amount		Assets		Liabilities		Amount		Assets		Liabilities
Derivatives not designated as hedging instruments:
Interest rate swaps	Interest rate	$	1,018,438	$	57,278	$	2,670	$	1,040,588	$	47,652	$	961
Financial futures	Equity	360,170		—		—		325,620		—		—
Foreign currency swaps	Foreign currency	149,698		—		4,629		149,698		504		4,659
Foreign currency forwards	Foreign currency	25,000		251		—		25,000		—		234
CPI swaps	CPI	388,151		—		20,505		385,580		—		11,384
Credit default swaps	Credit	1,348,300		6,614		58		1,338,300		6,003		1,166
Equity options	Equity	439,158		20,152		—		439,158		42,836		—
Longevity swaps	Longevity	897,440		48,869		—		917,360		47,789		—
Mortality swaps	Mortality	25,000		489		—		25,000		—		369
Synthetic GICs	Interest rate	13,895,380		—		—		13,397,729		—		—
Embedded derivatives in:
Modco or funds withheld arrangements		—		107,506		—		—		109,597		—
Indexed annuity products		—		—		754,171		—		—		776,940
Variable annuity products		—		—		149,764		—		—		167,925
Total non-hedging derivatives		18,546,735		241,159		931,797		18,044,033		254,381		963,638
Derivatives designated as hedging instruments:
Interest rate swaps	Foreign currency/Interest rate	435,000		891		24,436		435,000		—		27,257
Foreign currency swaps	Foreign currency	451,686		38,620		479		494,461		51,311		—
Foreign currency forwards	Foreign currency	949,879		32,862		—		911,197		50,974		—
Total hedging derivatives		1,836,565		72,373		24,915		1,840,658		102,285		27,257
Total derivatives		$	20,383,300	$	313,532	$	956,712	$	19,884,691	$	356,666	$	990,895

Fair Value Hedges

The Company designates and reports certain foreign currency swaps to hedge the foreign currency fair value exposure of foreign currency denominated assets as fair value hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The gain or loss on the hedged item attributable to a change in foreign currency and the offsetting gain or loss on the related foreign currency swaps as of March 31, 2019 and 2018, were (dollars in thousands):



Type of Fair Value Hedge	Hedged Item	Gains (Losses) Recognized for Derivatives			Gains (Losses) Recognized for Hedged Items
		Investment Related Gains (Losses)
For the three months ended March 31, 2019:
Foreign currency swaps	Foreign-denominated fixed maturity securities	$	(709	)	$	(703	)
For the three months ended March 31, 2018:
Foreign currency swaps	Foreign-denominated fixed maturity securities	$	(1,891	)	$	1,891

Cash Flow Hedges

Certain derivative instruments are designated as cash flow hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The Company designates and accounts for the following as cash flows: (i) certain interest rate swaps, in which the cash flows of liabilities are variable based on a benchmark rate; and (ii) certain interest rate swaps, in which the cash flows of assets are denominated in different currencies, commonly referred to as cross-currency swaps.

The following table presents the components of AOCI, before income tax, and the condensed consolidated income statement classification where the gain or loss is recognized related to cash flow hedges for the three months ended March 31, 2019 and 2018 (dollars in thousands):



	Three months ended March 31,
	2019			2018
Balance beginning of period	$	8,788		$	2,619
Gains (losses) deferred in other comprehensive income (loss)	(10,196		)	17,817
Amounts reclassified to investment income	(25		)	(144		)
Amounts reclassified to interest expense	(469		)	370
Balance end of period	$	(1,902	)	$	20,662

As of March 31, 2019, the before-tax deferred net gains (losses) on derivative instruments recorded in AOCI that are expected to be reclassified to earnings during the next twelve months are approximately $0.1 million and $1.7 million in investment income and interest expense, respectively.

The following table presents the effect of derivatives in cash flow hedging relationships on the condensed consolidated statements of income and the condensed consolidated statements of comprehensive income for the three months ended March 31, 2019 and 2018 (dollars in thousands):



Derivative Type	Gain (Loss) Deferred in OCI			Gain (Loss) Reclassified into Income from OCI
				Investment Income		Interest Expense
For the three months ended March 31, 2019:
Interest rate	$	(12,101	)	$	—	$	469
Currency/Interest rate	1,905			25		—
Total	$	(10,196	)	$	25	$	469
For the three months ended March 31, 2018:
Interest rate	$	14,986		$	—	$	(370	)
Currency/Interest rate	2,831			144		—
Total	$	17,817		$	144	$	(370	)

For the three months ended March 31, 2019 and 2018, 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.

Hedges of Net Investments in Foreign Operations

The Company uses foreign currency swaps and foreign currency forwards to hedge a portion of its net investment in certain foreign operations against adverse movements in exchange rates. The following table illustrates the Company’s net investments in foreign operations (“NIFO”) hedges for the three months ended March 31, 2019 and 2018 (dollars in thousands):



	Derivative Gains (Losses) Deferred in AOCI
	For the three months ended March 31,
Type of NIFO Hedge ⁽¹⁾	2019			2018
Foreign currency swaps	$	(7,007	)	$	8,805
Foreign currency forwards	(18,112		)	12,236


(1)	There were no sales or substantial liquidations of net investments in foreign operations that would have required the reclassification of gains or losses from accumulated other comprehensive income (loss) into investment income during the periods presented.

The cumulative foreign currency translation gain recorded in AOCI related to these hedges was $175.9 million and $201.0 million at March 31, 2019 and December 31, 2018, respectively. If a hedged foreign operation was sold or substantially liquidated, the amounts in AOCI would be reclassified to the condensed consolidated statements of income. A pro rata portion would be reclassified upon partial sale of a hedged foreign operation.

Non-qualifying Derivatives and Derivatives for Purposes Other Than Hedging

The Company uses various other derivative instruments for risk management purposes that either do not qualify or have not been qualified for hedge accounting treatment. The gain or loss related to the change in fair value for these derivative instruments is recognized in investment related gains (losses), net in the condensed consolidated statements of income, except where otherwise noted.

A summary of the effect of non-hedging derivatives, including embedded derivatives, on the Company’s condensed consolidated statements of income for the three months ended March 31, 2019 and 2018 is as follows (dollars in thousands):



		Gain (Loss) for the three months ended March 31,
Type of Non-hedging Derivative	Income Statement Location of Gain (Loss)	2019			2018
Interest rate swaps	Investment related gains (losses), net	$	23,974		$	(26,571	)
Financial futures	Investment related gains (losses), net	(22,278		)	129
Foreign currency swaps	Investment related gains (losses), net	723			—
Foreign currency forwards	Investment related gains (losses), net	492			323
CPI swaps	Investment related gains (losses), net	(8,851		)	2,186
Credit default swaps	Investment related gains (losses), net	14,500			(402		)
Equity options	Investment related gains (losses), net	(22,684		)	2,593
Longevity swaps	Other revenues	2,143			2,267
Mortality swaps	Other revenues	858			—
Subtotal		(11,123		)	(19,475		)
Embedded derivatives in:
Modco or funds withheld arrangements	Investment related gains (losses), net	(2,092		)	13,611
Indexed annuity products	Interest credited	3,070			25,351
Variable annuity products	Investment related gains (losses), net	18,161			14,785
Total non-hedging derivatives		$	8,016		$	34,272

Credit Derivatives

The following table presents the estimated fair value, maximum amount of future payments and weighted average years to maturity of credit default swaps sold by the Company at March 31, 2019 and December 31, 2018 (dollars in thousands):



	March 31, 2019					December 31, 2018
Rating Agency Designation of Referenced Credit Obligations⁽¹⁾	Estimated Fair Value of Credit Default Swaps		Maximum Amount of Future Payments under Credit Default Swaps⁽²⁾		Weighted Average Years to Maturity⁽³⁾	Estimated Fair Value of Credit Default Swaps			Maximum Amount of Future Payments under Credit Default Swaps⁽²⁾		Weighted Average Years to Maturity⁽³⁾
AAA/AA+/AA/AA-/A+/A/A-
Single name credit default swaps	$	2,082	$	157,000	2.1	$	1,953		$	152,000	2.2
Subtotal	2,082		157,000		2.1	1,953			152,000		2.2
BBB+/BBB/BBB-
Single name credit default swaps	3,672		358,700		2.0	2,930			353,700		2.2
Credit default swaps referencing indices	769		817,600		5.0	(76		)	817,600		6.4
Subtotal	4,441		1,176,300		4.1	2,854			1,171,300		5.1
BB+/BB/BB-
Single name credit default swaps	33		15,000		0.5	30			15,000		0.7
Subtotal	33		15,000		0.5	30			15,000		0.7
Total	$	6,556	$	1,348,300	3.8	$	4,837		$	1,338,300	4.7


(1)	The rating agency designations are based on ratings from Standard and Poor’s (“S&P”).


(2)	Assumes the value of the referenced credit obligations is zero.


(3)	The weighted average years to maturity of the credit default swaps is calculated based on weighted average notional amounts.

Netting Arrangements and Credit Risk

Certain of the Company’s derivatives are subject to enforceable master netting arrangements and reported as a net asset or liability in the condensed consolidated balance sheets. The Company nets all derivatives that are subject to such arrangements.

The Company has elected to include all derivatives, except embedded derivatives, in the tables below, irrespective of whether they are subject to an enforceable master netting arrangement or a similar agreement. See Note 4 – “Investments” for information regarding the Company’s securities borrowing, lending, repurchase and repurchase/reverse repurchase programs.

The following table provides information relating to the Company’s derivative instruments as of March 31, 2019 and December 31, 2018 (dollars in thousands):



								Gross Amounts Not Offset in the Balance Sheet
	Gross Amounts Recognized		Gross Amounts Offset in the Balance Sheet			Net Amounts Presented in the Balance Sheet		Financial Instruments ⁽¹⁾			Cash Collateral Pledged/ Received			Net Amount
March 31, 2019:
Derivative assets	$	206,026	$	(24,745	)	$	181,281	$	—		$	(205,177	)	$	(23,896	)
Derivative liabilities	52,777		(24,745		)	28,032		(63,992		)	(37,980		)	(73,940		)
December 31, 2018:
Derivative assets	$	247,069	$	(18,581	)	$	228,488	$	—		$	(235,611	)	$	(7,123	)
Derivative liabilities	46,030		(18,581		)	27,449		(71,376		)	(24,080		)	(68,007		)


(1)	Includes initial margin posted to a central clearing partner.

The Company may be exposed to credit-related losses in the event of non-performance by counterparties to derivative financial instruments with a positive fair value. Generally, the credit exposure of the Company’s derivative contracts is limited to the fair value at the reporting date plus or minus any collateral posted or held by the Company. The Company had no credit exposure related to its derivative contracts, as of March 31, 2019 and December 31, 2018, as the net amount of collateral pledged to the Company from counterparties exceeded the fair value of the derivative contracts.

Derivatives may be exchange-traded or they may be privately negotiated contracts, which are referred to as over-the-counter (“OTC”) derivatives. Certain of the Company’s OTC derivatives are cleared and settled through central clearing counterparties (“OTC cleared”) and others are bilateral contracts between two counterparties. The Company manages its credit risk related to OTC derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through the use of master netting agreements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. The Company is only exposed to the default of the central clearing counterparties for OTC cleared derivatives, and these transactions require initial and daily variation margin collateral postings. Exchange-traded derivatives are settled on a daily basis, thereby reducing the credit risk exposure in the event of non-performance by counterparties to such financial instruments.