XML 44 R10.htm IDEA: XBRL DOCUMENT v3.22.0.1
Derivative and Hedging Instruments
 12 Months Ended
Dec. 31, 2021
Text block [abstract]  
Derivative and Hedging Instruments
Note 4    Derivative and Hedging Instruments
Derivatives are financial contracts, the value of which is derived from underlying interest rates, foreign exchange rates, other financial instruments, commodity prices or indices. The Company uses derivatives including swaps, forward and futures agreements, and options to manage current and anticipated exposures to changes in interest rates, foreign exchange rates, commodity prices and equity market prices, and to replicate permissible investments.
Swaps are
over-the-counter
(“OTC”) contractual agreements between the Company and a third-party to exchange a series of cash flows based upon rates applied to a notional amount. For interest rate swaps, counterparties generally exchange fixed or floating interest rate payments based on a notional value in a single currency. Cross currency swaps involve the exchange of principal amounts between parties as well as the exchange of interest payments in one currency for the receipt of interest payments in another currency. Total return swaps are contracts that involve the exchange of payments based on changes in the values of a reference asset, including any returns such as interest earned on these assets, in return for amounts based on reference rates specified in the contract.
Forward and futures agreements are contractual obligations to buy or sell a financial instrument, foreign currency or other underlying commodity on a predetermined future date at a specified price. Forward contracts are OTC contracts negotiated between counterparties, whereas futures agreements are contracts with standard amounts and settlement dates that are traded on regulated exchanges.
Options are contractual agreements whereby the holder has the right, but not the obligation, to buy (call option) or sell (put option) a security, exchange rate, interest rate, or other financial instrument at a predetermined price/rate within a specified time.
See variable annuity dynamic hedging strategy in the “Risk Management and Risk Factors” section of the Company’s 2021 MD&A for an explanation of the Company’s dynamic hedging strategy for its variable annuity product guarantees.
(a) Fair value of derivatives
The pricing models used to value OTC derivatives are based on market standard valuation methodologies and the inputs to these models are consistent with what a market participant would use when pricing the instruments. Derivative valuations can be affected by changes in interest rates, currency exchange rates, financial indices, credit spreads, default risk (including the counterparties to the contract), and market volatility. The significant inputs to the pricing models for most OTC derivatives are inputs that are observable or can be corroborated by observable market data and are classified as Level 2. Inputs that are observable generally include interest rates, foreign currency exchange rates and interest rate curves. However, certain OTC derivatives may rely on inputs that are significant to the fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data and these derivatives are classified as Level 3. Inputs that are unobservable generally include broker quoted prices, volatilities and inputs that are outside of the observable portion of the interest rate curve or other relevant market measures. These unobservable inputs may involve significant management judgment or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate
given the circumstances and consistent with what market participants would use when pricing such instruments. The Company’s use of unobservable inputs is limited and the impact on derivative fair values does not represent a material amount as evidenced by the limited amount of Level 3 derivatives. The credit risk of both the counterparty and the Company are considered in determining the fair value for all OTC derivatives after considering the effects of netting agreements and collateral arrangements.
The following table presents gross notional amount and fair value of derivative instruments by the underlying risk exposure.
 
As at December 31,
  
2021
           2020  
        Notional
amount		     Fair value           Notional
amount		     Fair value  
Type of hedge
   Instrument type   Assets     Liabilities           Assets     Liabilities  
Qualifying hedge accounting relationships
                                                        
Fair value hedges
   Interest rate swaps  
$
–
 
  
$
–
 
  
$
–
 
          
$
82
 
  
$
1
 
  
$
–
 
    Foreign currency swaps  
 
57
 
  
 
1
 
  
 
1
 
          
 
57
 
  
 
–
 
  
 
4
 
Cash flow hedges
   Foreign currency swaps  
 
1,251
 
  
 
5
 
  
 
379
 
          
 
1,756
 
  
 
24
 
  
 
468
 
    Equity contracts  
 
145
 
  
 
10
 
  
 
–
 
          
 
127
 
  
 
6
 
  
 
–
 
Net investment hedges
   Forward contracts  
 
671
 
  
 
9
 
  
 
–
 
          
 
628
 
  
 
1
 
  
 
10
 
Total derivatives in qualifying hedge accounting relationships
  
 
2,124
 
  
 
25
 
  
 
380
 
             2,650       32       482  
Derivatives not designated in qualifying hedge accounting relationships
                                                        
    Interest rate swaps  
 
300,556
 
  
 
11,832
 
  
 
7,347
 
          
 
287,182
 
  
 
21,332
 
  
 
12,190
 
    Interest rate futures  
 
11,944
 
  
 
–
 
  
 
–
 
          
 
16,750
 
  
 
–
 
  
 
–
 
    Interest rate options  
 
10,708
 
  
 
514
 
  
 
–
 
          
 
11,622
 
  
 
663
 
  
 
–
 
    Foreign currency swaps  
 
36,405
 
  
 
790
 
  
 
1,722
 
          
 
31,491
 
  
 
838
 
  
 
1,659
 
    Currency rate futures  
 
3,086
 
  
 
–
 
  
 
–
 
          
 
3,467
 
  
 
–
 
  
 
–
 
    Forward contracts  
 
45,295
 
  
 
2,674
 
  
 
562
 
          
 
38,853
 
  
 
3,833
 
  
 
565
 
    Equity contracts  
 
18,577
 
  
 
1,667
 
  
 
27
 
          
 
15,738
 
  
 
1,092
 
  
 
66
 
    Credit default swaps  
 
44
 
  
 
1
 
  
 
–
 
          
 
241
 
  
 
3
 
  
 
–
 
 
   Equity futures  
 
11,359
 
  
 
–
 
  
 
–
 
          
 
10,984
 
  
 
–
 
  
 
–
 
Total derivatives not designated in qualifying hedge accounting relationships
  
 
437,974
 
  
 
17,478
 
  
 
9,658
 
             416,328       27,761       14,480  
Total derivatives
  
$
  440,098
 
  
$
  17,503
 
  
$
  10,038
 
           $   418,978     $   27,793     $   14,962  
The total notional amount above includes $258 billion (2020 – $274 billion) which refer to interest rates impacted under the interest rate benchmark reform, with a significant majority to USD LIBOR, CDOR and JPY LIBOR. Exposures indexed to USD LIBOR represent derivatives with a maturity date beyond June 30, 2023 while exposures to CDOR and JPY LIBOR represent derivatives with a maturity date beyond December 31, 2021. The exposure in the Company’s hedge accounting programs is primarily to USD LIBOR and CDOR benchmarks. Compared to the overall risk exposure, the effect of interest rate benchmark reform on existing accounting hedges is not significant. The Company continues to apply high probability and high effectiveness expectation assumptions for cash flows and there would be no automatic
de-designation
due to the impact from interest rate benchmark reform.
The following table presents the fair values of the derivative instruments by the remaining term to maturity. Fair values disclosed below do not incorporate the impact of master netting agreements (refer to note 8).
 
    Remaining term to maturity        
As at December 31, 2021
  
Less than
1 year
    
1 to 3
years
    
3 to 5
years
    
Over 5
years
     Total  
Derivative assets
  
$
2,500
 
  
$
1,803
 
  
$
1,000
 
  
$
12,200
 
  
$
17,503
 
Derivative liabilities
  
 
294
 
  
 
387
 
  
 
379
 
  
 
8,978
 
  
 
10,038
 
     
    Remaining term to maturity        
As at December 31, 2020  
Less than
1 year
    
1 to 3
years
    
3 to 5
years
    
Over 5
years
     Total  
Derivative assets
   $   1,656     $   3,524     $   1,228     $   21,385     $   27,793  
Derivative liabilities
     386       250       555       13,771       14,962  
The following table presents gross notional amount by the remaining term to maturity, total fair value (including accrued interest), credit equivalent amount and capital requirement by contract type.
 
    Remaining term to maturity (notional amounts)           Fair value          
Capital
requirement
(2)
  
As at December 31, 2021
  
Under 1
year
     1 to 
5 years		     Over
 5 years		     Total            Positive     Negative     Net    
Credit
equivalent
amount
(1)
  
Interest rate contracts
                                                                                
OTC swap contracts
  
$
4,554
 
  
$
21,884
 
  
$
90,592
 
  
$
117,030
 
          
$
12,112
 
  
$
(7,717
) 
  
$
4,395
 
  
$
1,582
 
  
$
29
 
Cleared swap contracts
  
 
21,722
 
  
 
27,665
 
  
 
134,139
 
  
 
183,526
 
          
 
441
 
  
 
(453
) 
  
 
(12
) 
  
 
–
 
  
 
–
 
Forward contracts
  
 
14,636
 
  
 
15,791
 
  
 
741
 
  
 
31,168
 
          
 
2,625
 
  
 
(483
) 
  
 
2,142
 
  
 
299
 
  
 
5
 
Futures
  
 
11,944
 
  
 
–
 
  
 
–
 
  
 
11,944
 
          
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
Options purchased
  
 
1,406
 
  
 
2,789
 
  
 
6,513
 
  
 
10,708
 
  
 
 
 
  
 
515
 
  
 
–
 
  
 
515
 
  
 
113
 
  
 
9
 
Subtotal
  
 
54,262
 
  
 
68,129
 
  
 
231,985
 
  
 
354,376
 
          
 
15,693
 
  
 
(8,653
) 
  
 
7,040
 
  
 
1,994
 
  
 
43
 
Foreign exchange
                                                                                
Swap contracts
  
 
1,941
 
  
 
8,869
 
  
 
26,903
 
  
 
37,713
 
          
 
801
 
  
 
(2,181
) 
  
 
(1,380
) 
  
 
1,302
 
  
 
25
 
Forward contracts
  
 
14,798
 
  
 
–
 
  
 
–
 
  
 
14,798
 
          
 
58
 
  
 
(79
) 
  
 
(21
) 
  
 
85
 
  
 
–
 
Futures
  
 
3,086
 
  
 
–
 
  
 
–
 
  
 
3,086
 
          
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
Credit derivatives
  
 
11
 
  
 
33
 
  
 
–
 
  
 
44
 
          
 
1
 
  
 
–
 
  
 
1
 
  
 
–
 
  
 
–
 
Equity contracts
                                                                                
Swap contracts
  
 
669
 
  
 
323
 
  
 
–
 
  
 
992
 
          
 
57
 
  
 
(10
) 
  
 
47
 
  
 
29
 
  
 
–
 
Futures
  
 
11,359
 
  
 
–
 
  
 
–
 
  
 
11,359
 
          
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
Options purchased
  
 
10,974
 
  
 
6,716
 
  
 
40
 
  
 
17,730
 
  
 
 
 
  
 
1,616
 
  
 
(17
) 
  
 
1,599
 
  
 
766
 
  
 
8
 
Subtotal including accrued interest
  
 
97,100
 
  
 
84,070
 
  
 
258,928
 
  
 
440,098
 
          
 
18,226
 
  
 
(10,940
) 
  
 
7,286
 
  
 
4,176
 
  
 
76
 
Less accrued interest
  
 
–
 
  
 
–
 
  
 
–
 
  
 
–
 
  
 
 
 
  
 
723
 
  
 
(902
) 
  
 
(179
) 
  
 
–
 
  
 
–
 
Total
  
$
  97,100
 
  
$
  84,070
 
  
$
  258,928
 
  
$
  440,098
 
  
 
 
 
  
$
  17,503
 
  
$
  (10,038)
 
  
$
  7,465
 
  
$
  4,176
 
  
$
  76
 
           
    Remaining term to maturity (notional amounts)           Fair value           Capital
requirement
(2)
  
As at December 31, 2020  
Under 1
year
     1 to
5 years		    

Over
5 years
     Total            Positive     Negative     Net    
Credit
equivalent
amount
(1)
  
Interest rate contracts
                                                                                
OTC swap contracts
   $ 7,567     $ 20,852     $ 110,166     $ 138,585             $ 21,803     $ (12,816 )    $ 8,987     $ 2,607     $ 73  
Cleared swap contracts
     2,314       18,784       127,581       148,679               432       (424 )      8       –       –  
Forward contracts
     11,092       18,355       1,259       30,706               3,739       (462 )      3,277       629       12  
Futures
     16,750       –       –       16,750               –       –       –       –       –  
Options purchased
     1,572       3,922       6,128       11,622    
 
 
 
     664       –       664       138       4  
Subtotal
     39,295       61,913       245,134       346,342               26,638       (13,702 )      12,936       3,374       89  
Foreign exchange
                                                                                
Swap contracts
     1,670       8,490       23,144       33,304               855       (2,195 )      (1,340 )      1,112       23  
Forward contracts
     8,741       34       –       8,775               95       (113 )      (18 )      56       –  
Futures
     3,467       –       –       3,467               –       –       –       –       –  
Credit derivatives
     192       49       –       241               3       –       3       –       –  
Equity contracts
                                                                                
Swap contracts
     1,227       289       –       1,516               43       (51 )      (8 )      27       –  
Futures
     10,984       –       –       10,984               –       –       –       –       –  
Options purchased
     8,168       6,181       –       14,349    
 
 
 
     1,051       (15 )      1,036       500       5  
Subtotal including accrued interest
     73,744       76,956       268,278       418,978               28,685       (16,076 )      12,609       5,069       117  
Less accrued interest
     –       –       –       –    
 
 
 
     892       (1,114 )      (222 )      –       –  
Total
   $   73,744     $   76,956     $   268,278     $   418,978    
 
 
 
   $   27,793     $   (14,962 )    $   12,831     $   5,069     $   117  
 
(1)
Credit equivalent amount is the sum of replacement cost and the potential future credit exposure less any collateral held. Replacement cost represents the current cost of replacing all contracts with a positive fair value. The amounts take into consideration legal contracts that permit offsetting of positions. The potential future credit exposure is calculated based on a formula prescribed by OSFI.
(2)
Capital requirement represents the credit equivalent amount, weighted according to the creditworthiness of the counterparty, as prescribed by OSFI.
The total notional amount of $440 billion (2020 – $419 billion) includes $121 billion (2020 – $131 billion) related to derivatives utilized in the Company’s variable annuity guarantee dynamic hedging and
macro risk hedging programs. Due to the Company’s variable annuity hedging practices, many trades are in offsetting positions, resulting in materially lower net fair value exposure to the Company than what the gross notional amount would suggest.
Fair value and the fair value hierarchy of derivative instruments
 
As at December 31, 2021
   Fair value     Level 1     Level 2     Level 3  
Derivative assets
                                
Interest rate contracts
  
$
14,971
 
  
$
–
 
  
$
12,510
 
  
$
2,461
 
Foreign exchange contracts
  
 
854
 
  
 
–
 
  
 
854
 
  
 
–
 
Equity contracts
  
 
1,677
 
  
 
–
 
  
 
1,616
 
  
 
61
 
Credit default swaps
  
 
1
 
  
 
–
 
  
 
1
 
  
 
–
 
Total derivative assets
  
$
17,503
 
  
$
–
 
  
$
14,981
 
  
$
2,522
 
Derivative liabilities
                                
Interest rate contracts
  
$
7,829
 
  
$
–
 
  
$
7,419
 
  
$
410
 
Foreign exchange contracts
  
 
2,182
 
  
 
–
 
  
 
2,181
 
  
 
1
 
Equity contracts
  
 
27
 
  
 
–
 
  
 
17
 
  
 
10
 
Total derivative liabilities
  
$
  10,038
 
  
$
  –
 
  
$
  9,617
 
  
$
  421
 
         
As at December 31, 2020   Fair value     Level 1     Level 2     Level 3  
Derivative assets
                                
Interest rate contracts
   $ 25,735     $ –     $ 21,902     $ 3,833  
Foreign exchange contracts
     957       –       957       –  
Equity contracts
     1,098       –       1,051       47  
Credit default swaps
     3       –       3       –  
Total derivative assets
   $ 27,793     $ –     $ 23,913     $ 3,880  
Derivative liabilities
                                
Interest rate contracts
   $ 12,652     $ –     $ 12,271     $ 381  
Foreign exchange contracts
     2,244       –       2,239       5  
Equity contracts
     66       –       15       51  
Total derivative liabilities
   $   14,962     $   –     $   14,525     $   437  
Level 3 roll forward information for net derivative contracts measured using significant unobservable inputs is disclosed in note 3(g).
(b) Hedging relationships
The Company uses derivatives for economic hedging purposes. In certain circumstances, these hedges also meet the requirements of hedge accounting. Risk management strategies eligible for hedge accounting are designated as fair value hedges, cash flow hedges or net investment hedges, as described below.
Fair value hedges
The Company uses interest rate swaps to manage its exposure to changes in the fair value of fixed rate financial instruments due to changes in interest rates. The Company also uses cross currency swaps to manage its exposure to foreign exchange rate fluctuations, interest rate fluctuations, or both.
The Company recognizes gains and losses on derivatives and the related hedged items in fair value hedges in investment income. These investment gains (losses) are shown in the following table.
 
For the year ended December 31, 2021
  
Hedged items in qualifying
fair value hedging
relationships
   Gains (losses)
recognized on
derivatives		     Gains (losses)
recognized for
hedged items		     Ineffectiveness
recognized in
investment
income		  
Interest rate swaps
  
Fixed rate liabilities
  
$
–
 
  
$
–
 
  
$
–
 
Foreign currency swaps
  
Fixed rate assets
  
 
4
 
  
 
(2
) 
  
 
2
 
Total
  
 
  
$
4
 
  
$
(2
) 
  
$
2
 
         
For the year ended December 31, 2020  
Hedged items in qualifying
fair value hedging
relationships
   Gains (losses)
recognized on
derivatives		     Gains (losses)
recognized for
hedged items		     Ineffectiveness
recognized in
investment
income		  
Interest rate swaps
  
Fixed rate liabilities
   $ 4     $ (2 )    $ 2  
Foreign currency swaps
  
Fixed rate assets
     (2 )      3       1  
Total
  
 
   $   2     $   1     $   3  
Cash flow hedges
The Company uses interest rate swaps to hedge the variability in cash flows from variable rate financial instruments and forecasted transactions. The Company also uses cross currency swaps and foreign currency forward contracts to hedge the variability from foreign
currency financial instruments and foreign currency expenses. Total return swaps are used to hedge the variability in cash flows associated with certain stock-based compensation awards. Inflation swaps are used to reduce inflation risk generated from inflation-indexed liabilities.
The effects of derivatives in cash flow hedging relationships on the Consolidated Statements of Income and the Consolidated Statements of Comprehensive Income are shown in the following table.
 
For the year ended December 31, 2021
   Hedged items in qualifying
cash flow hedging
relationships		   Gains (losses)
deferred in
AOCI on
derivatives		     Gains (losses)
reclassified
from AOCI into
investment
income		     Ineffectiveness
recognized in
investment
income		  
Foreign currency swaps
  
Fixed rate assets
  
$
(1
) 
  
$
(1
) 
  
$
–
 
   
Floating rate liabilities
  
 
89
 
  
 
3
 
  
 
–
 
   
Fixed rate liabilities
  
 
(19
) 
  
 
(21
) 
  
 
–
 
Equity contracts
  
Stock-based compensation
  
 
5
 
  
 
5
 
  
 
–
 
Total
  
 
  
$
  74
 
  
$
  (14)
 
  
$
  –
 
         
For the year ended December 31, 2020   Hedged items in qualifying
cash flow hedging
relationships		   Gains (losses)
deferred in
AOCI on
derivatives		     Gains (losses)
reclassified
from AOCI into
investment
income		     Ineffectiveness
recognized in
investment
income		  
Foreign currency swaps
  
Fixed rate assets
   $ 1     $ –     $ –  
   
Floating rate liabilities
     (64 )      14       –  
   
Fixed rate liabilities
     (14 )      (2 )      –  
Equity contracts
  
Stock-based compensation
     (2 )      16       –  
Total
  
 
   $   (79 )    $   28     $   –  
The Company anticipates that net losses of approximately $42 will be reclassified from AOCI to net income within the next 12 months. The maximum time frame for which variable cash flows are hedged is 15 years.
Hedges of net investments in foreign operations
The Company primarily uses forward currency contracts, cross currency swaps and
non-functional
currency denominated debt to manage its foreign currency exposures to net investments in foreign operations.
The effects of net investment hedging relationships on the Consolidated Statements of Income and the Consolidated Statements of Other Comprehensive Income are shown in the following table.
 
For the year ended December 31, 2021
   Gains (losses)
deferred in AOCI		     Gains (losses)
reclassified from
AOCI into
investment income		     Ineffectiveness
recognized in
investment
income		  
Non-functional
currency denominated debt
  
$
61
 
  
$
–
 
  
$
–
 
Forward contracts
  
 
59
 
  
 
–
 
  
 
–
 
Total
  
$
  120
 
  
$
  –
 
  
$
  –
 
For the year ended December 31, 2020   Gains (losses)
deferred in AOCI		     Gains (losses)
reclassified from
AOCI into
investment income		     Ineffectiveness
recognized in
investment
income		  
Non-functional
currency denominated debt
   $ 161     $ –     $ –  
Forward contracts
     (53 )      –       –  
Total
   $   108     $   –     $   –  
(c) Derivatives not designated in qualifying hedge accounting relationships
Derivatives used in portfolios supporting insurance contract liabilities are generally not designated in qualifying hedge accounting relationships because the change in the value of the insurance contract liabilities economically hedged by these derivatives is recorded through net income. Since changes in fair value of these derivatives and related hedged risks are recognized in investment income as they occur, they generally offset the change in hedged risk to the extent the hedges are economically effective. Interest rate and cross currency swaps are used in the portfolios supporting insurance contract liabilities to manage duration and currency risks.
 
Investment income on derivatives not designated in qualifying hedge accounting relationships
 
For the years ended December 31,
  
2021
     2020  
Interest rate swaps
  
$
(1,986
) 
   $ 2,423  
Interest rate futures
  
 
(687
) 
     894  
Interest rate options
  
 
(133
) 
     291  
Foreign currency swaps
  
 
(166
) 
     (55 ) 
Currency rate futures
  
 
66
 
     (47 ) 
Forward contracts
  
 
(1,751
) 
     3,785  
Equity futures
  
 
(2,140
) 
     (1,111 ) 
Equity contracts
  
 
871
 
     322  
Credit default swaps
  
 
(2
) 
     (4 ) 
Total
  
$
  (5,928)
 
   $   6,498  
(d) Embedded derivatives
Certain insurance contracts contain features that are classified as embedded derivatives and are measured separately at FVTPL, including reinsurance contracts related to guaranteed minimum income benefits and contracts containing certain credit and interest rate features.
Certain reinsurance contracts related to guaranteed minimum income benefits contain embedded derivatives requiring separate measurement at FVTPL as the financial component contained in the reinsurance contracts does not contain significant insurance risk. As at December 31, 2021, reinsurance ceded guaranteed minimum income benefits had a fair value of $734 (2020 – $1,007) and reinsurance assumed guaranteed minimum income benefits had a fair value of $86 (2020 – $112). Claims recovered under reinsurance ceded contracts offset claims expenses and claims paid on the reinsurance assumed are reported as contract benefits.
The Company’s credit and interest rate embedded derivatives promise to pay the returns on a portfolio of assets to the contract holder. These embedded derivatives contain credit and interest rate risks that are financial risks embedded in the underlying insurance contract. As at December 31, 2021, these embedded derivatives had a fair value of $11 (2020 – $(229)).
Other financial instruments classified as embedded derivatives but exempt from separate measurement at fair value include variable universal life and variable life products’ minimum guaranteed credited rates, no lapse guarantees, guaranteed annuitization options, CPI indexing of benefits, and segregated fund minimum guarantees other than reinsurance ceded/assumed guaranteed minimum income benefits. These embedded derivatives are measured and reported within insurance contract liabilities and are exempt from separate fair value measurement as they contain insurance risk and/or are closely related to the insurance host contract.