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Derivative Instruments
 9 Months Ended
Sep. 30, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments 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
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 September 30, 2019 and December 31, 2018 (dollars in thousands):
 
 
 
 
September 30, 2019
 
December 31, 2018
 
 
Primary Underlying Risk
 
Notional
 
Carrying Value/Fair Value
 
Notional
 
Carrying Value/Fair Value
 
 
 
Amount
 
Assets
 
Liabilities
 
Amount
 
Assets
 
Liabilities
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Interest rate
 
$
929,963

 
$
84,306

 
$
2,778

 
$
1,040,588

 
$
47,652

 
$
961

Financial futures
 
Equity
 
361,030

 
—

 
—

 
325,620

 
—

 
—

Foreign currency swaps
 
Foreign currency
 
149,698

 
—

 
12,454

 
149,698

 
504

 
4,659

Foreign currency forwards
 
Foreign currency
 
125,000

 
337

 
—

 
25,000

 
—

 
234

Consumer price index swaps
 
CPI
 
422,068

 
360

 
33,245

 
385,580

 
—

 
11,384

Credit default swaps
 
Credit
 
1,337,800

 
5,888

 
139

 
1,338,300

 
6,003

 
1,166

Equity options
 
Equity
 
386,536

 
24,844

 
—

 
439,158

 
42,836

 
—

Longevity swaps
 
Longevity
 
871,920

 
51,620

 
—

 
917,360

 
47,789

 
—

Mortality swaps
 
Mortality
 
25,000

 
—

 
853

 
25,000

 
—

 
369

Synthetic guaranteed investment contracts
 
Interest rate
 
13,919,866

 
—

 
—

 
13,397,729

 
—

 
—

Embedded derivatives in:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Modified coinsurance or funds withheld arrangements
 
 
 
—

 
121,275

 
—

 
—

 
109,597

 
—

Indexed annuity products
 
 
 
—

 
—

 
779,128

 
—

 
—

 
776,940

Variable annuity products
 
 
 
—

 
—

 
210,041

 
—

 
—

 
167,925

Total non-hedging derivatives
 
 
 
18,528,881

 
288,630

 
1,038,638

 
18,044,033

 
254,381

 
963,638

Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Foreign currency/Interest rate
 
435,000

 
—

 
34,467

 
435,000

 
—

 
27,257

Foreign currency swaps
 
Foreign currency
 
366,193

 
26,384

 
7,615

 
494,461

 
51,311

 
—

Foreign currency forwards
 
Foreign currency
 
1,025,548

 
43,441

 
—

 
911,197

 
50,974

 
—

Total hedging derivatives
 
 
 
1,826,741

 
69,825

 
42,082

 
1,840,658

 
102,285

 
27,257

Total derivatives
 
 
 
$
20,355,622

 
$
358,455

 
$
1,080,720

 
$
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 September 30, 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 September 30, 2019:
 
 
 
 
Foreign currency swaps
 
Foreign-denominated fixed maturity securities
 
$
(5,995
)
 
$
4,088

For the three months ended September 30, 2018:
 
 
 
 
Foreign currency swaps
 
Foreign-denominated fixed maturity securities
 
$
(2,258
)
 
$
2,832

For the nine months ended September 30, 2019:
 
 
 
 
Foreign currency swaps
 
Foreign-denominated fixed maturity securities
 
$
(10,422
)
 
$
4,503

For the nine months ended September 30, 2018:
 
 
 
 
Foreign currency swaps
 
Foreign-denominated fixed maturity securities
 
$
(5,284
)
 
$
9,666


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 flow hedges: (i) certain interest rate swaps, in which the cash flows of assets and 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 and nine months ended September 30, 2019 and 2018 (dollars in thousands):
 
 
Three months ended September 30,
 
 
2019
 
2018
Balance beginning of period
 
$
(14,862
)
 
$
22,656

Gains (losses) deferred in other comprehensive income (loss)
 
(32,123
)
 
6,671

Amounts reclassified to investment income
 
38

 
(50
)
Amounts reclassified to interest expense
 
(255
)
 
(234
)
Balance end of period
 
$
(47,202
)
 
$
29,043

 
 
 
 
 
 
 
Nine months ended September 30,
 
 
2019
 
2018
Balance beginning of period
 
$
8,788

 
$
2,619

Gains (losses) deferred in other comprehensive income (loss)
 
(54,902
)
 
26,586

Amounts reclassified to investment income
 
19

 
(270
)
Amounts reclassified to interest expense
 
(1,107
)
 
108

Balance end of period
 
$
(47,202
)
 
$
29,043


As of September 30, 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 $(0.8) 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 and nine months ended September 30, 2019 and 2018 (dollars in thousands):
Derivative Type
 
Gain (Loss) Deferred in AOCI
 
Gain (Loss) Reclassified into Income from AOCI
 
 
 
 
Investment Income
 
Interest Expense
For the three months ended September 30, 2019:
 
 
 
 
 
 
Interest rate
 
$
(24,846
)
 
$
—

 
$
255

Currency/Interest rate
 
(7,277
)
 
(38
)
 
—

Total
 
$
(32,123
)
 
$
(38
)
 
$
255

For the three months ended September 30, 2018:
 
 
 
 
 
 
Interest rate
 
$
7,490

 
$
—

 
$
234

Currency/Interest rate
 
(819
)
 
50

 
—

Total
 
$
6,671

 
$
50

 
$
234

 
 
 
 
 
 
 
For the nine months ended September 30, 2019:
 
 
 
 
 
 
Interest rate
 
$
(46,816
)
 
$
—

 
$
1,107

Currency/Interest rate
 
(8,086
)
 
(19
)
 
—

Total
 
$
(54,902
)
 
$
(19
)
 
$
1,107

For the nine months ended September 30, 2018:
 
 
 
 
 
 
Interest rate
 
$
27,217

 
$
—

 
$
(108
)
Currency/Interest rate
 
(631
)
 
270

 
—

Total
 
$
26,586

 
$
270

 
$
(108
)

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 and nine months ended September 30, 2019 and 2018 (dollars in thousands):
 
 
 
Derivative Gains (Losses) Deferred in AOCI     
 
 
For the three months ended September 30,
 
For the nine months ended September 30,
Type of NIFO Hedge (1)
 
2019
 
2018
 
2019
 
2018
Foreign currency swaps
 
$
3,930

 
$
(5,877
)
 
$
(5,563
)
 
$
11,125

Foreign currency forwards
 
16,427

 
(11,562
)
 
(7,669
)
 
11,737

Total
 
$
20,357

 
$
(17,439
)
 
$
(13,232
)
 
$
22,862

 
(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 $187.8 million and $201.0 million at September 30, 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 and nine months ended September 30, 2019 and 2018 is as follows (dollars in thousands):
 
 
 
 
Gain (Loss) for the three months ended
September 30,
Type of Non-hedging Derivative
 
Income Statement Location of Gain (Loss)
 
2019
 
2018
Interest rate swaps
 
Investment related gains (losses), net
 
$
38,701

 
$
(12,228
)
Financial futures
 
Investment related gains (losses), net
 
322

 
(6,544
)
Foreign currency swaps
 
Investment related gains (losses), net
 
867

 
—

Foreign currency forwards
 
Investment related gains (losses), net
 
337

 
(58
)
CPI swaps
 
Investment related gains (losses), net
 
(8,235
)
 
(4,223
)
Credit default swaps
 
Investment related gains (losses), net
 
1,961

 
4,689

Equity options
 
Investment related gains (losses), net
 
243

 
(9,793
)
Longevity swaps
 
Other revenues
 
2,063

 
2,426

Mortality swaps
 
Other revenues
 
—

 
473

Subtotal
 
 
 
36,259

 
(25,258
)
Embedded derivatives in:
 
 
 
 
 
 
Modified coinsurance or funds withheld arrangements
 
Investment related gains (losses), net
 
8,508

 
(2,081
)
Indexed annuity products
 
Interest credited
 
(44,972
)
 
(25,347
)
Variable annuity products
 
Investment related gains (losses), net
 
(42,233
)
 
32,133

Total non-hedging derivatives
 
 
 
$
(42,438
)
 
$
(20,553
)
 
 
 
 
 
 
 
 
 
 
 
Gain (Loss) for the nine months ended        
September 30,
Type of Non-hedging Derivative
 
Income Statement Location of Gain (Loss)
 
2019
 
2018
Interest rate swaps
 
Investment related gains (losses), net
 
$
96,079

 
$
(47,399
)
Financial futures
 
Investment related gains (losses), net
 
(29,641
)
 
(7,312
)
Foreign currency swaps
 
Investment related gains (losses), net
 
(4,790
)
 
—

Foreign currency forwards
 
Investment related gains (losses), net
 
571

 
3

CPI swaps
 
Investment related gains (losses), net
 
(23,898
)
 
(996
)
Credit default swaps
 
Investment related gains (losses), net
 
21,539

 
5,371

Equity options
 
Investment related gains (losses), net
 
(27,269
)
 
(15,207
)
Longevity swaps
 
Other revenues
 
6,390

 
6,983

Mortality swaps
 
Other revenues
 
(484
)
 
(326
)
Subtotal
 
 
 
38,497

 
(58,883
)
Embedded derivatives in:
 
 
 
 
 
 
Modified coinsurance or funds withheld arrangements
 
Investment related gains (losses), net
 
11,678

 
20,335

Indexed annuity products
 
Interest credited
 
(50,361
)
 
6,523

Variable annuity products
 
Investment related gains (losses), net
 
(42,116
)
 
62,242

Total non-hedging derivatives
 
 
 
$
(42,302
)
 
$
30,217



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 September 30, 2019 and December 31, 2018 (dollars in thousands):
 
 
September 30, 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
 
$
1,018

 
$
117,500

 
1.6
 
$
1,953

 
$
152,000

 
2.2
Credit default swaps referencing indices
 
342

 
240,000

 
10.2
 
—

 
—

 
0.0
Subtotal
 
1,360

 
357,500

 
7.4
 
1,953

 
152,000

 
2.2
BBB+/BBB/BBB-
 
 
 
 
 
 
 
 
 
 
 
 
Single name credit default swaps
 
4,103

 
337,700

 
2.0
 
2,930

 
353,700

 
2.2
Credit default swaps referencing indices
 
111

 
632,600

 
2.9
 
(76
)
 
817,600

 
6.4
Subtotal
 
4,214

 
970,300

 
2.6
 
2,854

 
1,171,300

 
5.1
BB+/BB/BB-
 
 
 
 
 
 
 
 
 
 
 
 
Single name credit default swaps
 
175

 
10,000

 
2.7
 
30

 
15,000

 
0.7
Subtotal
 
175

 
10,000

 
2.7
 
30

 
15,000

 
0.7
Total
 
$
5,749

 
$
1,337,800

 
3.9
 
$
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 September 30, 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   
September 30, 2019:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
 
$
237,180

 
$
(43,461
)
 
$
193,719

 
$
—

 
$
(205,890
)
 
$
(12,171
)
Derivative liabilities
 
91,551

 
(43,461
)
 
48,090

 
(81,090
)
 
(60,080
)
 
(93,080
)
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 September 30, 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.