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Derivative Financial Instruments | 12 Months Ended
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Dec. 31, 2014
Notes to Financial Statements [Abstract] |
Derivative Financial Instruments | Purpose of Derivatives We are exposed to certain risks relating to our ongoing business operations. The primary risks managed by using derivative instruments are interest rate risk, risk related to matching duration for our assets and liabilities, foreign currency risk, and credit risk. Historically, we have utilized current and forward interest rate swaps and options on forward interest rate swaps and U.S. Treasury rates, current and forward currency swaps, forward treasury locks, currency forward contracts, forward contracts on specific fixed income securities, and credit default swaps. Transactions hedging interest rate risk are primarily associated with our individual and group long-term care and individual and group disability products. All other product portfolios are periodically reviewed to determine if hedging strategies would be appropriate for risk management purposes. We do not use derivative financial instruments for speculative purposes. Derivatives designated as cash flow hedges and used to reduce our exposure to interest rate and duration risk are as follows:
• | Interest rate swaps are used to hedge interest rate risks and to improve the matching of assets and liabilities. An interest rate swap is an agreement in which we agree with other parties to exchange, at specified intervals, the difference between fixed rate and variable rate interest amounts. We use interest rate swaps to hedge the anticipated purchase of fixed maturity securities thereby protecting us from the potential adverse impact of declining interest rates on the associated policy reserves. We also use interest rate swaps to hedge the potential adverse impact of rising interest rates in anticipation of issuing fixed rate long-term debt.
• | Forward treasury locks are used to minimize interest rate risk associated with the anticipated purchase or disposal of fixed maturity securities. A forward treasury lock is a derivative contract without an initial investment where we and the counterparty agree to purchase or sell a specific U.S. Treasury bond at a future date at a pre-determined price.
• | Options on U.S. Treasury rates are used to hedge the interest rate risk associated with the anticipated purchase of fixed maturity securities. These options give us the right, but not the obligation, to receive a specific interest rate for a specified period of time. These options enable us to lock in a minimum investment yield to hedge the potential adverse impact of declining interest rates.
Derivatives designated as fair value hedges and used to reduce our exposure to interest rate and duration risk are as follows:
• | Interest rate swaps are used to effectively convert certain of our fixed rate securities into floating rate securities which are used to fund our floating rate long-term debt. Under these swap agreements, we receive a variable rate of interest and pay a fixed rate of interest. Additionally, we use interest rate swaps to effectively convert certain fixed rate, long-term debt into floating rate long-term debt. Under these swap agreements, we receive a fixed rate of interest and pay a variable rate of interest.
Derivatives designated as cash flow hedges and used to reduce our exposure to foreign currency risk are as follows:
• | Foreign currency interest rate swaps have historically been used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification and to hedge the currency risk associated with certain of the principal and interest payments of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries. For hedges of fixed maturity securities, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the operating segment. For hedges of debt issued, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments to the counterparty in exchange for fixed rate U.S. dollar-denominated principal and interest payments.
Derivatives not designated as hedging instruments and used to reduce our exposure to foreign currency risk and credit losses on securities owned are as follows:
• | Foreign currency interest rate swaps previously designated as hedges were used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification. We agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the operating segment. We hold offsetting swaps wherein we agree to pay fixed rate principal and interest payments in the functional currency of the operating segment in exchange for fixed rate foreign currency-denominated payments.
• | Credit default swaps are used as economic hedges against credit risk but do not qualify for hedge accounting. A credit default swap is an agreement in which we agree with another party to pay, at specified intervals, a fixed-rate fee in exchange for insurance against a credit event on a specific investment. If a defined credit event occurs, our counterparty may either pay us a net cash settlement, or we may surrender the specific investment to them in exchange for cash equal to the full notional amount of the swap. Credit events typically include events such as bankruptcy, failure to pay, or certain types of debt restructuring.
Derivative Risks The basic types of risks associated with derivatives are market risk (that the value of the derivative will be adversely impacted by changes in the market, primarily the change in interest and exchange rates) and credit risk (that the counterparty will not perform according to the terms of the contract). The market risk of the derivatives should generally offset the market risk associated with the hedged financial instrument or liability. To help limit the credit exposure of the derivatives, we enter into master netting agreements with our counterparties whereby contracts in a gain position can be offset against contracts in a loss position. We also typically enter into bilateral, cross-collateralization agreements with our counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed upon amount. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position, including accrued interest receivable less collateral held, was $13.6 million at December 31, 2014. We held cash collateral from our counterparties of $15.4 million and $1.1 million at December 31, 2014 and 2013, respectively. We post either fixed maturity securities or cash as collateral to our counterparties. The carrying value of fixed maturity securities posted as collateral to our counterparties was $67.0 million and $95.6 million at December 31, 2014 and 2013, respectively. We had no cash posted as collateral to our counterparties at December 31, 2014 and 2013. See Note 3 for further discussion of our master netting agreements. The majority of our derivative instruments contain provisions that require us to maintain specified issuer credit ratings and financial strength ratings. Should our ratings fall below these specified levels, we would be in violation of the provisions, and our derivatives counterparties could terminate our contracts and request immediate payment. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a liability position was $92.9 million and $135.6 million at December 31, 2014 and 2013, respectively. Derivative Transactions The table below summarizes, by notional amounts, the activity for each category of derivatives. The notional amounts represent the basis upon which our counterparty pay and receive amounts are calculated.
| Swaps |  |  |  |  |  |
| Receive Variable/Pay Fixed |  | Receive Fixed/Pay Fixed |  | Receive Fixed/Pay Variable |  | Credit Default |  | Forwards |  | Options |  | Total
| (in millions of dollars)
Balance at December 31, 2011 | $ | 174.0 |  |  | $ | 554.0 |  |  | $ | 685.0 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 1,413.0 |
Additions | — |  |  | — |  |  | 250.0 |  |  | — |  |  | 86.0 |  |  | — |  |  | 336.0 |
Terminations | — |  |  | 45.2 |  |  | 185.0 |  |  | — |  |  | 86.0 |  |  | — |  |  | 316.2 |
Balance at December 31, 2012 | 174.0 |  |  | 508.8 |  |  | 750.0 |  |  | — |  |  | — |  |  | — |  |  | 1,432.8 |
Additions | — |  |  | 160.0 |  |  | — |  |  | 97.0 |  |  | 24.0 |  |  | 10.0 |  |  | 291.0 |
Terminations | 24.0 |  |  | 38.4 |  |  | 150.0 |  |  | — |  |  | 24.0 |  |  | 10.0 |  |  | 246.4 |
Balance at December 31, 2013 | 150.0 |  |  | 630.4 |  |  | 600.0 |  |  | 97.0 |  |  | — |  |  | — |  |  | 1,477.4 |
Additions | — |  |  | 250.1 |  |  | — |  |  | — |  |  | 68.0 |  |  | — |  |  | 318.1 |
Terminations | — |  |  | 40.1 |  |  | — |  |  | — |  |  | 68.0 |  |  | — |  |  | 108.1 |
Balance at December 31, 2014 | $ | 150.0 |  |  | $ | 840.4 |  |  | $ | 600.0 |  |  | $ | 97.0 |  |  | $ | — |  |  | $ | — |  |  | $ | 1,687.4 |
Cash Flow Hedges As of December 31, 2014 and 2013, we had $618.0 million and $630.4 million, respectively, notional amount of receive fixed, pay fixed, open current and forward foreign currency interest rate swaps to hedge fixed income foreign currency-denominated securities and U.S. dollar-denominated debt issued by one of our U.K. subsidiaries. During 2014, we novated certain of our foreign currency interest rate swaps with a notional amount of $97.0 million and a fair value of $(29.5) million to a new counterparty. At the time of novation, these derivatives were effective hedges, and we therefore deferred the unrealized loss into other comprehensive income and will recognize the loss in earnings during the periods in which the hedged items affect earnings. In conjunction with the novation, these derivatives were de-designated as hedges, and subsequent changes in their fair value will be reported in earnings as a component of net realized investment gain or loss. To establish a new effective hedging relationship with the fixed income foreign currency denominated securities previously hedged, we entered into $124.7 million notional amount of foreign currency interest rate swaps during 2014 whereby we receive fixed rate functional currency principal and interest in exchange for fixed rate payments in foreign currency. During 2014, we redeemed a portion of the outstanding principal of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries. In conjunction with this redemption, we reclassified $13.1 million of the deferred gain on cash flow hedges from accumulated other comprehensive income to realized investment gain in our consolidated statements of income. This amount represents the applicable portion of the deferred gain from previously terminated derivatives associated with the hedge of this debt. See Note 8. During 2013, we entered into $150.0 million notional amount of foreign currency swaps to hedge the currency risk on a portion of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries. Also during 2013, we terminated, as scheduled, $150.0 million notional amount of received fixed, pay variable forward starting interest rate swaps used to hedge the anticipated purchase of fixed maturity securities. For the years ended December 31, 2014, 2013, and 2012 there was no material ineffectiveness related to our cash flow hedges, and no component of the derivative instruments' gain or loss was excluded from the assessment of hedge effectiveness. As of December 31, 2014, we expect to amortize approximately $50.2 million of net deferred gains on derivative instruments during the next twelve months. This amount will be reclassified from accumulated other comprehensive income into earnings and reported on the same income statement line item as the hedged item. The income statement line items that will be affected by this amortization are net investment income and interest and debt expense. The remaining principal balance of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries is scheduled to mature during the fourth quarter of 2015, at which time we will reclassify the remaining deferred cash flow hedge gain of approximately $28.4 million from accumulated other comprehensive income to realized investment gain in our consolidated statements of income. Additional amounts that may be reclassified from accumulated other comprehensive income into earnings to offset the earnings impact of foreign currency translation of hedged items are not estimable. As of December 31, 2014, we are hedging the variability of future cash flows associated with forecasted transactions through the year 2038. Fair Value Hedges As of December 31, 2014 and 2013, we had $150.0 million notional amount of receive variable, pay fixed interest rate swaps to hedge the changes in fair value of certain fixed rate securities held. These swaps effectively convert the associated fixed rate securities into floating rate securities, which are used to fund our floating rate long-term debt. The change in fair value of the hedged fixed maturity securities attributable to the hedged benchmark interest rate resulted in a loss of $5.3 million, $11.5 million, and $1.2 million for the years ended December 31, 2014, 2013, and 2012, respectively, with an offsetting gain on the related interest rate swaps. As of December 31, 2014 and 2013, we had $600.0 million notional amount of receive fixed, pay variable interest rate swaps to hedge the changes in the fair value of certain fixed rate long-term debt. These swaps effectively convert the associated fixed rate long-term debt into floating rate debt and provide for a better matching of interest rates with our short-term investments, which have frequent interest rate resets similar to a floating rate security. The change in fair value of the hedged debt attributable to the hedged benchmark interest rate resulted in a gain (loss) of $(5.5) million, $21.1 million, and $(6.6) million for the years ended December 31, 2014, 2013, and 2012, respectively, with an offsetting gain or loss on the related interest rate swaps. For the years ended December 31, 2014, 2013, and 2012, there was no material ineffectiveness related to our fair value hedges, and no component of the derivative instruments' gain or loss was excluded from the assessment of hedge effectiveness. There were no instances wherein we discontinued fair value hedge accounting due to a hedged firm commitment no longer qualifying as a fair value hedge. Derivatives not Designated as Hedging Instruments During 2014, we entered into $125.4 million notional amount of foreign currency interest rate swaps in conjunction with the previously discussed transaction wherein we de-designated foreign currency interest rate swaps with a notional amount of $97.0 million. The derivatives were not designated as hedges, and as such, changes in fair value related to these derivatives will be reported in earnings as a component of net realized investment gain or loss. We expect the changes in fair value of these derivatives to materially offset the changes in fair value related to the de-designated derivatives. As of December 31, 2014 and 2013, we held $97.0 million notional amount of single name credit default swaps. We entered into these swaps in order to mitigate the credit risk associated with specific securities owned. We have an embedded derivative in a modified coinsurance arrangement for which we include in our realized investment gains and losses a calculation intended to estimate the value of the option of our reinsurance counterparty to cancel the reinsurance contract with us. However, neither party can unilaterally terminate the reinsurance agreement except in extreme circumstances resulting from regulatory supervision, delinquency proceedings, or other direct regulatory action. Cash settlements or collateral related to this embedded derivative are not required at any time during the reinsurance contract or at termination of the reinsurance contract. There are no credit-related counterparty triggers, and any accumulated embedded derivative gain or loss reduces to zero over time as the reinsured business winds down. Locations and Amounts of Derivative Financial Instruments The following tables summarize the location and fair values of derivative financial instruments, as reported in our consolidated balance sheets.
| December 31, 2014
| Asset Derivatives |  | Liability Derivatives
| Balance Sheet Location |  | Fair Value |  | Balance Sheet Location |  | Fair Value
| (in millions of dollars)
Designated as Hedging Instruments |  |  |  |  |  |  |
Interest Rate Swaps | Other L-T Investments |  | $ | 5.7 |  |  | Other Liabilities |  | $ | 20.8 |
Foreign Exchange Contracts | Other L-T Investments |  | 22.3 |  |  | Other Liabilities |  | 39.6 |
Total |  |  | $ | 28.0 |  |  |  |  | $ | 60.4 |
Not Designated as Hedging Instruments |  |  |  |  |  |  |
Credit Default Swaps |  |  |  |  | Other Liabilities |  | $ | 1.2 |
Foreign Exchange Contracts |  |  |  |  | Other Liabilities |  | 31.3 |
Embedded Derivative in Modified Coinsurance Arrangement |  |  |  |  | Other Liabilities |  | 49.9 |
Total |  |  |  |  |  |  | $ | 82.4 |
| December 31, 2013
| Asset Derivatives |  | Liability Derivatives
| Balance Sheet Location |  | Fair Value |  | Balance Sheet Location |  | Fair Value
| (in millions of dollars)
Designated as Hedging Instruments |  |  |  |  |  |  |
Interest Rate Swaps | Other L-T Investments |  | $ | 9.2 |  |  | Other Liabilities |  | $ | 35.0 |
Foreign Exchange Contracts | Other L-T Investments |  | 1.6 |  |  | Other Liabilities |  | 98.7 |
Total |  |  | $ | 10.8 |  |  |  |  | $ | 133.7 |
Not Designated as Hedging Instruments |  |  |  |  |  |  |
Credit Default Swaps |  |  |  |  | Other Liabilities |  | $ | 1.9 |
Embedded Derivative in Modified Coinsurance Arrangement |  |  |  |  | Other Liabilities |  | 53.2 |
Total |  |  |  |  |  |  | $ | 55.1 |
The following table summarizes the location of gains and losses on the effective portion of derivative financial instruments designated as cash flow hedging instruments, as reported in our consolidated statements of income and consolidated statements of comprehensive income.
|  | Year Ended December 31
|  | 2014 |  | 2013 |  | 2012
|  | (in millions of dollars)
Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives |  |  |  |  |
Interest Rate Swaps and Forwards | $ | (0.1 | ) |  | $ | (7.2 | ) |  | $ | 77.9 |
Options | — |  |  | (0.1 | ) |  | — |
Foreign Exchange Contracts | 16.2 |  |  | 22.6 |  |  | 3.5 |
| Total | $ | 16.1 |  |  | $ | 15.3 |  |  | $ | 81.4 |
Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income |  |  |  |  |
Net Investment Income |  |  |  |  |
| Interest Rate Swaps and Forwards | $ | 47.8 |  |  | $ | 43.1 |  |  | $ | 40.0 |
| Foreign Exchange Contracts | (4.2 | ) |  | (5.9 | ) |  | (5.3 | )
Net Realized Investment Gain (Loss) |  |  |  |  |
| Interest Rate Swaps | 4.3 |  |  | 1.3 |  |  | 4.1 |
| Foreign Exchange Contracts | 6.9 |  |  | (13.8 | ) |  | (17.0 | )
Interest and Debt Expense |  |  |  |  |
| Interest Rate Swaps | (1.8 | ) |  | (1.7 | ) |  | (1.7 | )
| Total | $ | 53.0 |  |  | $ | 23.0 |  |  | $ | 20.1 |
The following table summarizes the location of gains and losses on our derivatives not designated as hedging instruments, as reported in our consolidated statements of income.
|  | Year Ended December 31
|  | 2014 |  | 2013 |  | 2012
|  | (in millions of dollars)
Net Realized Investment Gain (Loss) |  |  |  |  |
| Credit Default Swaps | $ | (0.3 | ) |  | $ | (1.9 | ) |  | $ | — |
| Foreign Exchange Contracts | (1.8 | ) |  | — |  |  | — |
| Embedded Derivative in Modified Coinsurance Arrangement | 3.3 |  |  | 30.7 |  |  | 51.8 |
| Total | $ | 1.2 |  |  | $ | 28.8 |  |  | $ | 51.8 |

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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://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 30 -Section 50 -Paragraph 1 -URI http://asc.fasb.org/extlink&oid=35736893&loc=d3e80748-113994 Reference 2: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4A -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5618551-113959 Reference 3: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4K -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5708775-113959 Reference 4: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 25 -Section 50 -Paragraph 1 -URI http://asc.fasb.org/extlink&oid=6886632&loc=d3e76258-113986 Reference 5: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4E -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5624181-113959 Reference 6: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 30 -Section 45 -Paragraph 1 -URI http://asc.fasb.org/extlink&oid=6441202&loc=d3e80720-113993 Reference 7: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4H -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5624258-113959 Reference 8: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4B -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5624163-113959 Reference 9: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 235 -SubTopic 10 -Section S99 -Paragraph 1 -Subparagraph (SX 210.4-08.(n)) -URI http://asc.fasb.org/extlink&oid=26873400&loc=d3e23780-122690 Reference 10: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4J -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5708773-113959 Reference 11: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 30 -Section 50 -Paragraph 2 -URI http://asc.fasb.org/extlink&oid=35736893&loc=d3e80784-113994 Reference 12: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4D -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5624177-113959 Reference 13: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 2 -URI http://asc.fasb.org/extlink&oid=35706170&loc=d3e41620-113959 Reference 14: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 1A -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5579245-113959 Reference 15: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 1B -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5580258-113959 Reference 16: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 1 -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5579240-113959 Reference 17: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 5 -URI http://asc.fasb.org/extlink&oid=35706170&loc=d3e41641-113959 Reference 18: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4 -URI http://asc.fasb.org/extlink&oid=35706170&loc=d3e41638-113959 Reference 19: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -SubTopic 10 -Section 50 -Paragraph 4C -URI http://asc.fasb.org/extlink&oid=35706170&loc=SL5624171-113959 + Details
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