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Derivative Financial Instruments | 9 Months Ended
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Sep. 30, 2023
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
Derivative Financial Instruments |
Note 6 | 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, futures, 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. In 2022, the Company also had derivatives embedded in non-derivative host contracts that were 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. In connection with the sale of ALIC and certain affiliates in 2021, the sale agreement included a provision related to contingent consideration that may be earned over a ten-year period with the first potential payment date commencing on January 1, 2026 and a final potential payment date of January 1, 2035. The contingent consideration is determined annually based on the average 10-year Treasury rate over the preceding 3-year period compared to a designated rate. The contingent consideration meets the definition of a derivative and is accounted for on a fair value basis with periodic changes in fair value reflected in earnings. There are no collateral requirements related to the contingent consideration.
Summary of the volume and fair value positions of derivative instruments as of September 30, 2023
($ 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 |  | 10,126 |  |  | $ | 1 |  |  | $ | 1 |  |  | $ | — |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other assets |  | n/a |  | 1,451 |  |  | 1 |  |  | 1 |  |  | — |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other investments |  | $ | 267 |  |  | n/a |  | 3 |  |  | 5 |  |  | (2) |
Contingent consideration | Other assets |  | 250 |  |  | n/a |  | 113 |  |  | 113 |  |  | — |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other investments |  | 37 |  |  | n/a |  | — |  |  | — |  |  | — |
Total asset derivatives |  |  | $ | 554 |  |  | 11,577 |  |  | $ | 118 |  |  | $ | 120 |  |  | $ | (2) |
Liability derivatives |  |  |  |  |  |  |  |  |  |  |
Derivatives not designated as accounting hedging instruments |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 5,312 |  |  | $ | (2) |  |  | $ | — |  |  | $ | (2) |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 1,995 |  |  | (1) |  |  | — |  |  | (1) |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other liabilities & accrued expenses |  | $ | 354 |  |  | n/a |  | 12 |  |  | 14 |  |  | (2) |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other liabilities & accrued expenses |  | 567 |  |  | n/a |  | (5) |  |  | 1 |  |  | (6) |
Total liability derivatives |  |  | 921 |  |  | 7,307 |  |  | 4 |  |  | $ | 15 |  |  | $ | (11) |
Total derivatives |  |  | $ | 1,475 |  |  | 18,884 |  |  | $ | 122 |  |  |  |  |
(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, 2022
($ 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 |  | 24,380 |  |  | $ | 3 |  |  | $ | 3 |  |  | $ | — |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other assets |  | n/a |  | 343 |  |  | — |  |  | — |  |  | — |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other investments |  | $ | 354 |  |  | n/a |  | 1 |  |  | 14 |  |  | (13) |
Contingent consideration | Other assets |  | 250 |  |  | n/a |  | 103 |  |  | 103 |  |  | — |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other investments |  | 24 |  |  | n/a |  | — |  |  | 1 |  |  | (1) |
Total asset derivatives |  |  | $ | 628 |  |  | 24,723 |  |  | $ | 107 |  |  | $ | 121 |  |  | $ | (14) |
Liability derivatives |  |  |  |  |  |  |  |  |  |  |
Derivatives not designated as accounting hedging instruments |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 1,624 |  |  | $ | — |  |  | $ | — |  |  | $ | — |
Equity and index contracts |  |  |  |  |  |  |  |  |  |  |
Futures | Other liabilities & accrued expenses |  | n/a |  | 1,229 |  |  | (1) |  |  | — |  |  | (1) |
Foreign currency contracts |  |  |  |  |  |  |  |  |  |  |
Foreign currency forwards | Other liabilities & accrued expenses |  | $ | 283 |  |  | n/a |  | — |  |  | 7 |  |  | (7) |
Credit default contracts |  |  |  |  |  |  |  |  |  |  |
Credit default swaps – buying protection | Other liabilities & accrued expenses |  | 525 |  |  | n/a |  | (3) |  |  | 1 |  |  | (4) |
Total liability derivatives |  |  | 808 |  |  | 2,853 |  |  | (4) |  |  | $ | 8 |  |  | $ | (12) |
Total derivatives |  |  | $ | 1,436 |  |  | 27,576 |  |  | $ | 103 |  |  |  |  |
(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)
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, 2023 |  |  |  |  |  |  |  |  |  |  |  |
Asset derivatives |  | $ | 20 |  |  | $ | (17) |  |  | $ | 1 |  |  | $ | 4 |  |  | $ | — |  |  | $ | 4 |
Liability derivatives |  | (5) |  |  | 17 |  |  | (13) |  |  | (1) |  |  | — |  |  | (1) |
December 31, 2022 |  |  |  |  |  |  |  |  |  |  |  |
Asset derivatives |  | $ | 23 |  |  | $ | (22) |  |  | $ | — |  |  | $ | 1 |  |  | $ | — |  |  | $ | 1 |
Liability derivatives |  | (22) |  |  | 22 |  |  | (1) |  |  | (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) |  | Net gains (losses) on investments and derivatives |  | Operating costs and expenses |  | Total gain (loss) recognized in net income on derivatives
Three months ended September 30, 2023 |  |  |  |  |  |
Interest rate contracts |  | $ | 5 |  |  | $ | — |  |  | $ | 5 |
Equity and index contracts |  | 10 |  |  | (10) |  |  | — |
Contingent consideration |  | — |  |  | 9 |  |  | 9 |
Foreign currency contracts |  | 17 |  |  | — |  |  | 17 |
Credit default contracts |  | (1) |  |  | — |  |  | (1) |
Total |  | $ | 31 |  |  | $ | (1) |  |  | $ | 30 |
Nine months ended September 30, 2023 |  |  |  |  |  |
Interest rate contracts |  | $ | (12) |  |  | $ | — |  |  | $ | (12) |
Equity and index contracts |  | (6) |  |  | 8 |  |  | 2 |
Contingent consideration |  | — |  |  | 10 |  |  | 10 |
Foreign currency contracts |  | 6 |  |  | — |  |  | 6 |
Credit default contracts |  | (16) |  |  | — |  |  | (16) |
Total |  | $ | (28) |  |  | $ | 18 |  |  | $ | (10) |
Three months ended September 30, 2022 |  |  |  |  |  |
Interest rate contracts |  | $ | 260 |  |  | $ | — |  |  | $ | 260 |
Equity and index contracts |  | 9 |  |  | (8) |  |  | 1 |
Contingent consideration |  | — |  |  | (4) |  |  | (4) |
Foreign currency contracts |  | 40 |  |  | (6) |  |  | 34 |
Credit default contracts |  | (10) |  |  | — |  |  | (10) |
Other contracts |  | — |  |  | (1) |  |  | (1) |
Total |  | $ | 299 |  |  | $ | (19) |  |  | $ | 280 |
Nine months ended September 30, 2022 |  |  |  |  |  |
Interest rate contracts |  | $ | 734 |  |  | $ | — |  |  | $ | 734 |
Equity and index contracts |  | 65 |  |  | (55) |  |  | 10 |
Contingent consideration |  | — |  |  | 39 |  |  | 39 |
Foreign currency contracts |  | 84 |  |  | (8) |  |  | 76 |
Credit default contracts |  | 6 |  |  | — |  |  | 6 |
Other contracts |  | — |  |  | (1) |  |  | (1) |
Total |  | $ | 889 |  |  | $ | (25) |  |  | $ | 864 |
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, 2023
Pledged by the Company |  | $ | 4 |
Pledged to the Company (1) |  | 16 |
(1) No collateral was posted under MNAs 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, 2023 |  | December 31, 2022
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+ |  | 4 |  |  | $ | 672 |  |  | $ | 15 |  |  | $ | — |  |  | 1 |  |  | $ | 128 |  |  | $ | 5 |  |  | $ | — |
A |  | — |  |  | — |  |  | — |  |  | — |  |  | 1 |  |  | 192 |  |  | 7 |  |  | — |
Total |  | 4 |  |  | $ | 672 |  |  | $ | 15 |  |  | $ | — |  |  | 2 |  |  | $ | 320 |  |  | $ | 12 |  |  | $ | — |
(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, 2023
Pledged by the Company |  | $ | 178 |
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 table 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, 2023 |  | December 31, 2022
Gross liability fair value of contracts containing credit-risk-contingent features |  | $ | 4 |  |  | $ | 21 |
Gross asset fair value of contracts containing credit-risk-contingent features and subject to MNAs |  | (4) |  |  | (11) |
Collateral posted under MNAs for contracts containing credit-risk-contingent features |  | — |  |  | (10) |
Maximum amount of additional exposure for contracts with credit-risk-contingent features if all features were triggered concurrently |  | $ | — |  |  | $ | — |

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