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Derivative Financial Instruments | 9 Months Ended
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Sep. 30, 2021
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
Derivative Financial Instruments |
Note 7 | Derivative Financial Instruments
The Company uses derivatives for risk reduction and to increase investment portfolio returns through asset replication. Risk reduction activity is focused on managing the risks with certain assets and liabilities arising from the potential adverse impacts from changes in risk-free interest rates, changes in equity market valuations, increases in credit spreads and foreign currency fluctuations. Asset replication refers to the “synthetic” creation of assets through the use of derivatives. The Company replicates fixed income securities using a combination of a credit default swap, index total return swap, options, or a foreign currency forward contract and one or more highly rated fixed income securities, primarily investment grade host bonds, to synthetically replicate the economic characteristics of one or more cash market securities. The Company replicates equity securities using futures, index total return swaps, and options to increase equity exposure. Property-Liability may use interest rate swaps, swaptions, futures and options to manage the interest rate risks of existing investments. These instruments are utilized to change the duration of the portfolio in order to offset the economic effect that interest rates would otherwise have on the fair value of its fixed income securities. Fixed income index total return swaps are used to offset valuation losses in the fixed income portfolio during periods of declining market values. Credit default swaps are typically used to mitigate the credit risk within the Property-Liability fixed income portfolio. Equity index total return swaps, futures and options are used by Property-Liability to offset valuation losses in the equity portfolio during periods of declining equity market values. In addition, equity futures are used to hedge the market risk related to deferred compensation liability contracts. Forward contracts are primarily used by Property-Liability to hedge foreign currency risk associated with holding foreign currency denominated investments and foreign operations. The Company also has derivatives embedded in non-derivative host contracts that are required to be separated from the host contracts and accounted for at fair value with changes in fair value of embedded derivatives reported in net income. When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair value, cash flow, foreign currency fair value or foreign currency cash flow hedges. The notional amounts specified in the contracts are used to calculate the exchange of contractual payments under the agreements and are generally not representative of the potential for gain or loss on these agreements. However, the notional amounts specified in credit default swaps where the Company has sold credit protection represent the maximum amount of potential loss, assuming no recoveries. Fair value, which is equal to the carrying value, is the estimated amount that the Company would receive or pay to terminate the derivative contracts at the reporting date. The carrying value amounts for OTC derivatives are further adjusted for the effects, if any, of enforceable master netting agreements and are presented on a net basis, by counterparty agreement, in the Condensed Consolidated Statements of Financial Position. For those derivatives which qualify and have been designated as fair value accounting hedges, net income includes the changes in the fair value of both the derivative instrument and the hedged risk. For cash flow hedges, gains and losses are amortized from AOCI and are reported in net income in the same period the forecasted transactions being hedged impact net income. Non-hedge accounting is generally used for “portfolio” level hedging strategies where the terms of the individual hedged items do not meet the strict homogeneity requirements to permit the application of hedge accounting. For non-hedge derivatives, net income includes changes in fair value and accrued periodic settlements, when applicable. With the exception of non-hedge derivatives used for asset replication and non-hedge embedded derivatives, all of the Company’s derivatives are evaluated for their ongoing effectiveness as either accounting hedge or non-hedge derivative financial instruments on at least a quarterly basis. Assets and liabilities held for sale Asset-liability management is a risk management practice that is principally employed by the life and annuity business to balance the respective interest-rate sensitivities of its assets and liabilities. Depending upon the attributes of the assets acquired and liabilities issued, derivative instruments such as interest rate swaps, caps, swaptions and futures are utilized to change the interest rate characteristics of existing assets and liabilities to ensure the relationship is maintained within specified ranges and to reduce exposure to rising or falling interest rates. Fixed income index total return swaps are used to offset valuation losses in the portfolio during periods of declining market values. Credit default swaps are typically used to mitigate the credit risk within the life and annuity fixed income portfolios. Futures and options are used for hedging the equity exposure contained in equity indexed life and annuity product contracts that offer equity returns to contractholders. In addition, the Company uses equity index total return swaps, options and futures to offset valuation losses in the equity portfolio during periods of declining equity market values. Foreign currency swaps and forwards are primarily used to reduce the foreign currency risk associated with holding foreign currency denominated investments. The Company’s primary embedded derivatives are equity options in life and annuity product contracts, which provide returns linked to equity indices to contractholders.
Summary of the volume and fair value positions of derivative instruments as of September 30, 2021
($ in millions, except number of contracts) |  |  | Volume (1) |  |  |  |  |  |
Balance sheet location |  | Notional amount |  | Number of contracts |  | Fair value, net |  | Gross asset |  | Gross liability
Asset derivatives |  |  |  |  |  |  |  |  |  |  |
Derivatives not designated as accounting hedging instruments |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other assets |  | n/a |  | 479 |  |  | $ | — |  |  | $ | — |  |  | $ | — |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Options | Other investments |  | n/a |  | 61 |  |  | 4 |  |  | 4 |  |  | — |
Futures | Other assets |  | n/a |  | 1,390 |  |  | 4 |  |  | 4 |  |  | — |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other investments |  | $ | 137 |  |  | n/a |  | 1 |  |  | 2 |  |  | (1) |
Embedded derivative financial instruments |  |  |  |  |  |  |  |  |  |
Other embedded derivative financial instruments | Other investments |  | 750 |  |  | n/a |  | — |  |  | — |  |  | — |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other investments |  | 33 |  |  | n/a |  | (1) |  |  | — |  |  | (1) |
Credit default swaps – selling protection | Other investments |  | 750 |  |  | n/a |  | 14 |  |  | 14 |  |  | — |
Assets held for sale |  |  | 3 |  |  | 2,561 |  |  | 126 |  |  | 126 |  |  | — |
Total asset derivatives |  |  | $ | 1,673 |  |  | 4,491 |  |  | $ | 148 |  |  | $ | 150 |  |  | $ | (2) |
Liability derivatives |  |  |  |  |  |  |  |  |  |  |
Derivatives not designated as accounting hedging instruments |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 4,019 |  |  | $ | (1) |  |  | $ | — |  |  | $ | (1) |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 1,411 |  |  | (3) |  |  | — |  |  | (3) |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other liabilities & accrued expenses |  | $ | 607 |  |  | n/a |  | 14 |  |  | 19 |  |  | (5) |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other liabilities & accrued expenses |  | 881 |  |  | n/a |  | (28) |  |  | — |  |  | (28) |
Credit default swaps – selling protection | Other liabilities & accrued expenses |  | 5 |  |  | n/a |  | — |  |  | — |  |  | — |
Liabilities held for sale |  |  | 2,146 |  |  | 2,554 |  |  | (549) |  |  | 3 |  |  | (552) |
Total liability derivatives |  |  | 3,639 |  |  | 7,984 |  |  | (567) |  |  | $ | 22 |  |  | $ | (589) |
Total derivatives |  |  | $ | 5,312 |  |  | 12,475 |  |  | $ | (419) |  |  |  |  |
(1) Volume for OTC and cleared derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable)
Summary of the volume and fair value positions of derivative instruments as of December 31, 2020
($ in millions, except number of contracts) |  |  | Volume |  |  |  |  |  |
Balance sheet location |  | Notional amount |  | Number of contracts |  | Fair value, net |  | Gross asset |  | Gross liability
Asset derivatives |  |  |  |  |  |  |  |  |  |  |
Derivatives not designated as accounting hedging instruments |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other assets |  | n/a |  | 290 |  |  | $ | — |  |  | $ | — |  |  | $ | — |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Options | Other investments |  | n/a |  | 56 |  |  | 6 |  |  | 6 |  |  | — |
Futures | Other assets |  | n/a |  | 905 |  |  | 1 |  |  | 1 |  |  | — |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other investments |  | $ | 291 |  |  | n/a |  | 4 |  |  | 9 |  |  | (5) |
Embedded derivative financial instruments |  |  |  |  |  |  |  |  |  |  |
Other embedded derivative financial instruments | Other investments |  | 750 |  |  | n/a |  | — |  |  | — |  |  | — |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other investments |  | 60 |  |  | n/a |  | (3) |  |  | — |  |  | (3) |
Credit default swaps – selling protection | Other investments |  | 750 |  |  | n/a |  | 13 |  |  | 13 |  |  | — |
Assets held for sale |  |  | 158 |  |  | 3,189 |  |  | 185 |  |  | 189 |  |  | (4) |
Total asset derivatives |  |  | $ | 2,009 |  |  | 4,440 |  |  | $ | 206 |  |  | $ | 218 |  |  | $ | (12) |
Liability derivatives |  |  |  |  |  |  |  |  |  |  |
Derivatives not designated as accounting hedging instruments |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 705 |  |  | $ | — |  |  | $ | — |  |  | $ | — |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 666 |  |  | — |  |  | — |  |  | — |
Total return index contracts |  |  |  |  |  |  |  |  |  |  |
Total return swap agreements – fixed income | Other liabilities & accrued expenses |  | $ | 50 |  |  | n/a |  | — |  |  | — |  |  | — |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other liabilities & accrued expenses |  | 250 |  |  | n/a |  | (9) |  |  | 1 |  |  | (10) |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other liabilities & accrued expenses |  | 638 |  |  | n/a |  | (16) |  |  | — |  |  | (16) |
Credit default swaps – selling protection | Other liabilities & accrued expenses |  | 4 |  |  | n/a |  | — |  |  | — |  |  | — |
Liabilities held for sale |  |  | 2,240 |  |  | 2,737 |  |  | (630) |  |  | 1 |  |  | (631) |
Total liability derivatives |  |  | 3,182 |  |  | 4,108 |  |  | (655) |  |  | $ | 2 |  |  | $ | (657) |
Total derivatives |  |  | $ | 5,191 |  |  | 8,548 |  |  | $ | (449) |  |  |  |  |
Gross and net amounts for OTC derivatives (1)
($ in millions) |  |  |  | Offsets |  |  |  |  |  |
| Gross amount |  | Counter-party netting |  | Cash collateral (received) pledged |  | Net amount on balance sheet |  | Securities collateral (received) pledged |  | Net amount
September 30, 2021 |  |  |  |  |  |  |  |  |  |  |  |
Asset derivatives |  | $ | 21 |  |  | $ | (21) |  |  | $ | 2 |  |  | $ | 2 |  |  | $ | — |  |  | $ | 2 |
Liability derivatives |  | (9) |  |  | 21 |  |  | (20) |  |  | (8) |  |  | — |  |  | (8) |
December 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |
Asset derivatives |  | $ | 10 |  |  | $ | (9) |  |  | $ | — |  |  | $ | 1 |  |  | $ | — |  |  | $ | 1 |
Liability derivatives |  | (19) |  |  | 9 |  |  | 9 |  |  | (1) |  |  | — |  |  | (1) |
(1)All OTC derivatives are subject to enforceable master netting agreements.
Gains (losses) from valuation and settlements reported on derivatives not designated as accounting hedges
($ in millions) |  | Realized capital gains (losses) |  |  |  | Operating costs and expenses |  | Total gain (loss) recognized in net income on derivatives
Three months ended September 30, 2021 |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 18 |  |  |  |  | $ | — |  |  | $ | 18 |
Equity and index contracts |  | 10 |  |  |  |  | (3) |  |  | 7 |
Foreign currency contracts |  | 15 |  |  |  |  | — |  |  | 15 |
Credit default contracts |  | 1 |  |  |  |  | — |  |  | 1 |
Total return swaps - fixed income |  | 2 |  |  |  |  | — |  |  | 2 |
Total |  | $ | 46 |  |  |  |  | $ | (3) |  |  | $ | 43 |
Nine months ended September 30, 2021 |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 19 |  |  |  |  | $ | — |  |  | $ | 19 |
Equity and index contracts |  | 2 |  |  |  |  | 27 |  |  | 29 |
Foreign currency contracts |  | 23 |  |  |  |  | — |  |  | 23 |
Credit default contracts |  | 6 |  |  |  |  | — |  |  | 6 |
Total return swaps - fixed income |  | 4 |  |  |  |  | — |  |  | 4 |
Total |  | $ | 54 |  |  |  |  | $ | 27 |  |  | $ | 81 |
Three months ended September 30, 2020 |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | (1) |  |  |  |  | $ | — |  |  | $ | (1) |
Equity and index contracts |  | (12) |  |  |  |  | 12 |  |  | — |
Foreign currency contracts |  | (15) |  |  |  |  | — |  |  | (15) |
Credit default contracts |  | (3) |  |  |  |  | — |  |  | (3) |
Total return swaps - fixed income |  | 2 |  |  |  |  | — |  |  | 2 |
Total return swaps - equity index |  | (1) |  |  |  |  | — |  |  | (1) |
Total |  | $ | (30) |  |  |  |  | $ | 12 |  |  | $ | (18) |
Nine months ended September 30, 2020 |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 35 |  |  |  |  | $ | — |  |  | $ | 35 |
Equity and index contracts |  | 18 |  |  |  |  | (2) |  |  | 16 |
Foreign currency contracts |  | 6 |  |  |  |  | — |  |  | 6 |
Credit default contracts |  | — |  |  |  |  | — |  |  | — |
Total return swaps - fixed income |  | — |  |  |  |  | — |  |  | — |
Total return swaps - equity index |  | 3 |  |  |  |  | — |  |  | 3 |
Total |  | $ | 62 |  |  |  |  | $ | (2) |  |  | $ | 60 |
The Company manages its exposure to credit risk by utilizing highly rated counterparties, establishing risk control limits, executing legally enforceable master netting agreements (“MNAs”) and obtaining collateral where appropriate. The Company uses MNAs for OTC derivative transactions that permit either party to net payments due for transactions and collateral is either pledged or obtained when certain predetermined exposure limits are exceeded.
OTC cash and securities collateral pledged
($ in millions) |  | September 30, 2021
Pledged by the Company |  | $ | 2 |
Pledged to the Company (1) |  | 20 |
(1)Includes no collateral posted under MNA’s for contracts containing credit-risk-contingent provisions that are in a liability provision. The Company has not incurred any losses on derivative financial instruments due to counterparty nonperformance. Other derivatives, including futures and certain option contracts, are traded on organized exchanges which require margin deposits and guarantee the execution of trades, thereby mitigating any potential credit risk. Counterparty credit exposure represents the Company’s potential loss if all of the counterparties concurrently fail to perform under the contractual terms of the contracts and all collateral, if any, becomes worthless. This exposure is measured by the fair value of OTC derivative contracts with a positive fair value at the reporting date reduced by the effect, if any, of legally enforceable master netting agreements.
OTC derivatives counterparty credit exposure by counterparty credit rating
($ in millions) |  | September 30, 2021 |  | December 31, 2020
Rating (1) |  | Number of counter- parties |  | Notional amount (2) |  | Credit exposure (2) |  | Exposure, net of collateral (2) |  | Number of counter- parties |  | Notional amount (2) |  | Credit exposure (2) |  | Exposure, net of collateral (2)
A+ |  | 1 |  |  | $ | 198 |  |  | $ | 5 |  |  | $ | 1 |  |  | 1 |  |  | $ | 186 |  |  | $ | 4 |  |  | $ | — |
A |  | 1 |  |  | 387 |  |  | 10 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Total |  | 2 |  |  | $ | 585 |  |  | $ | 15 |  |  | $ | 1 |  |  | 1 |  |  | $ | 186 |  |  | $ | 4 |  |  | $ | — |
(1) Allstate uses the lower of S&P’s or Moody’s long-term debt issuer ratings. (2) Only OTC derivatives with a net positive fair value are included for each counterparty. For certain exchange traded and cleared derivatives, margin deposits are required as well as daily cash settlements of margin accounts.
Exchange traded and cleared margin deposits
($ in millions) |  | September 30, 2021
Pledged by the Company |  | $ | 88 |
Received by the Company |  | — |
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. Market risk exists for all of the derivative financial instruments the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions. To limit this risk, the Company’s senior management has established risk control limits. In addition, changes in fair value of the derivative financial instruments that the Company uses for risk management purposes are generally offset by the change in the fair value or cash flows of the hedged risk component of the related assets, liabilities or forecasted transactions. Certain of the Company’s derivative transactions contain credit-risk-contingent termination events and cross-default provisions. Credit-risk-contingent termination events allow the counterparties to terminate the derivative agreement or a specific trade on certain dates if AIC’s financial strength credit ratings by Moody’s or S&P fall below a certain level. Credit-risk-contingent cross-default provisions allow the counterparties to terminate the derivative agreement if the Company defaults by pre-determined threshold amounts on certain debt instruments. The following summarizes the fair value of derivative instruments with termination, cross-default or collateral credit-risk-contingent features that are in a liability position, as well as the fair value of assets and collateral that are netted against the liability in accordance with provisions within legally enforceable MNAs.
($ in millions) |  | September 30, 2021 |  | December 31, 2020
Gross liability fair value of contracts containing credit-risk-contingent features |  | $ | 7 |  |  | $ | 19 |
Gross asset fair value of contracts containing credit-risk-contingent features and subject to MNAs |  | (6) |  |  | (6) |
Collateral posted under MNAs for contracts containing credit-risk-contingent features |  | — |  |  | (13) |
Maximum amount of additional exposure for contracts with credit-risk-contingent features if all features were triggered concurrently |  | $ | 1 |  |  | $ | — |
Credit derivatives - selling protection A credit default swap (“CDS”) is a derivative instrument, representing an agreement between two parties to exchange the credit risk of a specified entity (or a group of entities), or an index based on the credit risk of a group of entities (all commonly referred to as the “reference entity” or a portfolio of “reference entities”), in return for a periodic premium. In selling protection, CDS are used to replicate fixed income securities and to complement the cash market when credit exposure to certain issuers is not available or when the derivative alternative is less expensive than the cash market alternative. CDS typically have a five-year term.
CDS notional amounts by credit rating and fair value of protection sold
($ in millions) |  | Notional amount |  |
| AAA |  | AA |  | A |  | BBB |  | BB and lower |  | Total |  | Fair value
September 30, 2021 |  |  |  |  |  |  |  |  |  |  |  |  |  |
Single name |  |  |  |  |  |  |  |  |  |  |  |  |  |
Corporate debt |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 5 |  |  | $ | 5 |  |  | $ | — |
Index |  |  |  |  |  |  |  |  |  |  |  |  |  |
Corporate debt |  | 6 |  |  | 12 |  |  | 150 |  |  | 492 |  |  | 90 |  |  | 750 |  |  | 14 |
Total |  | $ | 6 |  |  | $ | 12 |  |  | $ | 150 |  |  | $ | 492 |  |  | $ | 95 |  |  | $ | 755 |  |  | $ | 14 |
December 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |
Single name |  |  |  |  |  |  |  |  |  |  |  |  |  |
Corporate debt |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 4 |  |  | $ | 4 |  |  | $ | — |
Index |  |  |  |  |  |  |  |  |  |  |  |  |  |
Corporate debt |  | 6 |  |  | 12 |  |  | 156 |  |  | 492 |  |  | 84 |  |  | 750 |  |  | 13 |
Total |  | $ | 6 |  |  | $ | 12 |  |  | $ | 156 |  |  | $ | 492 |  |  | $ | 88 |  |  | $ | 754 |  |  | $ | 13 |
In selling protection with CDS, the Company sells credit protection on an identified single name, a basket of names in a first-to-default (“FTD”) structure or credit derivative index (“CDX”) that is generally investment grade, and in return receives periodic premiums through expiration or termination of the agreement. With single name CDS, this premium or credit spread generally corresponds to the difference between the yield on the reference entity’s public fixed maturity cash instruments and swap rates at the time the agreement is executed. With a FTD basket, because of the additional credit risk inherent in a basket of named reference entities, the premium generally corresponds to a high proportion of the sum of the credit spreads of the names in the basket and the correlation between the names. CDX is utilized to take a position on multiple (generally 125) reference entities. Credit events are typically defined as bankruptcy, failure to pay, or restructuring, depending on the nature of the reference entities. If a credit event occurs, the Company settles with the counterparty, either through physical settlement or cash settlement. In a physical settlement, a reference asset is delivered by the buyer of protection to the Company, in exchange for cash payment at par, whereas in a cash settlement, the Company pays the difference between par and the prescribed value of the reference asset. When a credit event occurs in a single name or FTD basket (for FTD, the first credit event occurring for any one name in the basket), the contract terminates at the time of settlement. For CDX, the reference entity’s name incurring the credit event is removed from the index while the contract continues until expiration. The maximum payout on a CDS is the contract notional amount. A physical settlement may afford the Company with recovery rights as the new owner of the asset. The Company monitors risk associated with credit derivatives through individual name credit limits at both a credit derivative and a combined cash instrument/credit derivative level. The ratings of individual names for which protection has been sold are also monitored.

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- Definition The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI http://asc.fasb.org/topic&trid=2229140 Reference 2: http://www.xbrl.org/2003/role/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 40 -Section 50 -Paragraph 5 -Subparagraph (f) -URI http://asc.fasb.org/extlink&oid=123477628&loc=d3e90205-114008 + Details
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