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Derivative Financial Instruments | 3 Months Ended
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Mar. 31, 2018
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, 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.
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 either cash flow or fair value hedges and used to reduce our exposure to foreign currency risk are as follows:
• | Foreign currency interest rate swaps are used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification. Under these swap agreements, 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.
Derivatives not designated as hedging instruments and used to reduce our exposure to foreign currency risk, credit losses on securities owned, and interest rate risk 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. These derivatives were effective hedges prior to novation to a new counterparty. In conjunction with the novation, these derivatives were de-designated as hedges. 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.
• | Interest rate swap was used to effectively convert certain of our floating rate, long-term debt into fixed rate long-term debt. Under this swap agreement, we received a variable rate of interest and paid a fixed rate of interest.
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 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 $0.1 million at March 31, 2018. The table below summarizes the nature and amount of collateral received from and posted to our derivative counterparties.
|  | March 31, 2018 |  | December 31, 2017
|  | (in millions of dollars)
Carrying Value of Collateral Received from Counterparties |  |  |  |
Cash |  | $ | 16.2 |  |  | $ | 15.7 |
Carrying Value of Collateral Posted to Counterparties |  |  |  |
Fixed Maturity Securities |  | $ | 49.6 |  |  | $ | 46.4 |
See Note 4 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 $51.4 million and $52.2 million at March 31, 2018 and December 31, 2017, 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 |  | Total
| (in millions of dollars)
Balance at December 31, 2016 | $ | 105.5 |  |  | $ | 616.5 |  |  | $ | 250.0 |  |  | $ | 70.0 |  |  | $ | 10.0 |  |  | $ | 1,052.0 |
Additions | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Terminations | 0.1 |  |  | 20.3 |  |  | — |  |  | — |  |  | 10.0 |  |  | 30.4 |
Balance at March 31, 2017 | $ | 105.4 |  |  | $ | 596.2 |  |  | $ | 250.0 |  |  | $ | 70.0 |  |  | $ | — |  |  | $ | 1,021.6 |
Balance at December 31, 2017 | $ | 48.0 |  |  | $ | 536.5 |  |  | $ | 250.0 |  |  | $ | 70.0 |  |  | $ | — |  |  | $ | 904.5 |
Additions | — |  |  | 19.9 |  |  | — |  |  | — |  |  | 26.8 |  |  | 46.7 |
Terminations | — |  |  | — |  |  | — |  |  | 70.0 |  |  | — |  |  | 70.0 |
Balance at March 31, 2018 | $ | 48.0 |  |  | $ | 556.4 |  |  | $ | 250.0 |  |  | $ | — |  |  | $ | 26.8 |  |  | $ | 881.2 |
Cash Flow Hedges As of March 31, 2018 and December 31, 2017, we had $343.9 million notional amount of receive fixed, pay fixed, open current and forward foreign currency interest rate swaps to hedge fixed income foreign currency-denominated securities. As of March 31, 2018, we expect to amortize approximately $65.1 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. 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 March 31, 2018, we are hedging the variability of future cash flows associated with forecasted transactions through the year 2038. Fair Value Hedges As of March 31, 2018 and December 31, 2017, we had $48.0 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 $0.5 million and $1.1 million for the three months ended March 31, 2018 and 2017, respectively, with an offsetting gain on the related interest rate swaps. As of March 31, 2018, we had $19.9 million notional amount of receive fixed, pay fixed, open current and forward foreign currency interest rate swaps to hedge fixed income foreign currency-denominated securities. The change in fair value of the hedged fixed maturity securities attributable to the change in the foreign currency exchange rate resulted in a loss of $0.3 million during the three months ended March 31, 2018 with an offsetting gain on the related forward foreign currency interest rate swaps. As of March 31, 2018 and December 31, 2017, we had $250.0 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 of $2.4 million and $0.5 million for the three months ended March 31, 2018 and 2017, respectively, with an offsetting loss on the related interest rate swaps. The following table summarizes the carrying amount of hedged assets and liabilities and the related cumulative basis adjustments related to our fair value hedges.
| Carrying Amount of Hedged Assets (Liabilities) |  | Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets (Liabilities)
| March 31, 2018 |  | December 31, 2017 |  | March 31, 2018 |  | December 31, 2017
| (in millions of dollars)
Fixed maturity securities: |  |  |  |  |  |  |
Receive variable interest rate, pay fixed interest rate | $ | 48.1 |  |  | $ | 48.5 |  |  | $ | 0.1 |  |  | $ | 0.6 |
Receive fixed foreign currency interest, pay fixed foreign currency interest | 19.4 |  |  | — |  |  | (0.3 | ) |  | — |
Long-term Debt | (242.5 | ) |  | (244.8 | ) |  | 6.9 |  |  | 4.5 |
For the three months ended March 31, 2018, a de minimis amount of the derivative instruments' gain or loss was excluded from the assessment of hedge effectiveness. For the three months ended March 31, 2017, 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 As of March 31, 2018 and December 31, 2017, we held $192.6 million notional amount of receive fixed, pay fixed, foreign currency interest rate swaps. These derivatives are not designated as hedges, and as such, changes in fair value related to these derivatives are reported in earnings as a component of net realized investment gain or loss. As of December 31, 2017, we held $70.0 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. These swaps matured during the first quarter of 2018 and a de minimis gain was recognized on the maturities. 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.
| March 31, 2018
| Derivative Assets |  | Derivative Liabilities
| Balance Sheet Location |  | Fair Value |  | Balance Sheet Location |  | Fair Value
| (in millions of dollars)
Designated as Hedging Instruments |  |  |  |  |  |  |
Cash Flow Hedges |  |  |  |  |  |  |
Forwards | Other L-T Investments |  | $ | — |  |  | Other Liabilities |  | $ | 0.2 |
Foreign Exchange Contracts | Other L-T Investments |  | 21.2 |  |  | Other Liabilities |  | 17.4 |
Total Cash Flow Hedges |  |  | 21.2 |  |  |  |  | 17.6 |
Fair Value Hedges |  |  |  |  |  |  |
Interest Rate Swaps | Other L-T Investments |  | — |  |  | Other Liabilities |  | 7.0 |
Foreign Exchange Contracts | Other L-T Investments |  | 0.3 |  |  | Other Liabilities |  | — |
Total Fair Value Hedges |  |  | 0.3 |  |  |  |  | 7.0 |
Total Designated as Hedging Instruments |  |  | $ | 21.5 |  |  |  |  | $ | 24.6 |
Not Designated as Hedging Instruments |  |  |  |  |  |  |
Foreign Exchange Contracts |  |  |  |  | Other Liabilities |  | $ | 26.8 |
Embedded Derivative in Modified Coinsurance Arrangement |  |  |  |  | Other Liabilities |  | 17.6 |
Total Not Designated as Hedging Instruments |  |  |  |  |  |  | $ | 44.4 |
| December 31, 2017
| Derivative Assets |  | Derivative Liabilities
| Balance Sheet Location |  | Fair Value |  | Balance Sheet Location |  | Fair Value
| (in millions of dollars)
Designated as Hedging Instruments |  |  |  |  |  |  |
Cash Flow Hedges |  |  |  |  |  |  |
Foreign Exchange Contracts | Other L-T Investments |  | $ | 19.5 |  |  | Other Liabilities |  | $ | 19.4 |
Total Cash Flow Hedges |  |  | 19.5 |  |  |  |  | 19.4 |
Fair Value Hedges |  |  |  |  |  |  |
Interest Rate Swaps | Other L-T Investments |  | — |  |  | Other Liabilities |  | 5.1 |
Total Fair Value Hedges |  |  | — |  |  |  |  | 5.1 |
Total Designated as Hedging Instruments |  |  | $ | 19.5 |  |  |  |  | $ | 24.5 |
Not Designated as Hedging Instruments |  |  |  |  |  |  |
Credit Default Swaps |  |  |  |  | Other Liabilities |  | $ | 0.2 |
Foreign Exchange Contracts |  |  |  |  | Other Liabilities |  | 27.5 |
Embedded Derivative in Modified Coinsurance Arrangement |  |  |  |  | Other Liabilities |  | 15.9 |
Total Not Designated as Hedging Instruments |  |  |  |  |  |  | $ | 43.6 |
The following table summarizes the location of gains and losses of derivative financial instruments designated as hedging instruments, as reported in our consolidated statements of income.
| Three Months Ended March 31
| 2018 |  | 2017
| Net Investment Income |  | Net Realized Investment Gain (Loss) |  | Interest and Debt Expense |  | Net Investment Income |  | Net Realized Investment Gain (Loss) |  | Interest and Debt Expense
| (in millions of dollars)
Total Income and Expense Presented in the Consolidated Statements of Income of Which Hedged Items are Recorded | $ | 602.3 |  |  | $ | (2.2 | ) |  | $ | 40.2 |  |  | $ | 602.4 |  |  | $ | 11.0 |  |  | $ | 39.8 |
Gain (Loss) on Cash Flow Hedging Relationships |  |  |  |  |  |  |  |  |  |  |
Interest Rate Swaps: |  |  |  |  |  |  |  |  |  |  |
Hedged items | 77.8 |  |  | 0.1 |  |  | 11.4 |  |  | 81.9 |  |  | 0.2 |  |  | 11.4 |
Derivatives Designated as Hedging Instruments | 15.9 |  |  | (0.1 | ) |  | 0.6 |  |  | 14.6 |  |  | — |  |  | 0.5 |
Foreign Exchange Contracts |  |  |  |  |  |  |  |  |  |  |
Hedged items | 5.0 |  |  | — |  |  | — |  |  | 5.4 |  |  | 1.2 |  |  | — |
Derivatives Designated as Hedging Instruments | (0.3 | ) |  | — |  |  | — |  |  | (0.2 | ) |  | (1.2 | ) |  | — |
Gain (Loss) on Fair Value Hedging Relationships |  |  |  |  |  |  |  |  |  |  |
Interest Rate Swaps: |  |  |  |  |  |  |  |  |  |  |
Hedged items | 0.7 |  |  | 1.9 |  |  | 3.6 |  |  | 1.4 |  |  | (0.6 | ) |  | 3.6 |
Derivatives Designated as Hedging Instruments | (0.4 | ) |  | (1.9 | ) |  | 0.1 |  |  | (1.0 | ) |  | 0.6 |  |  | (0.3 | )
Foreign Exchange Contracts |  |  |  |  |  |  |  |  |  |  |
Hedged items | 0.1 |  |  | (0.3 | ) |  | — |  |  | — |  |  | — |  |  | — |
Derivatives Designated as Hedging Instruments | — |  |  | 0.3 |  |  | — |  |  | — |  |  | — |  |  | — |
The following table summarizes the location of gains and losses of derivative financial instruments designated as cash flow hedging instruments, as reported in our consolidated statements of comprehensive income.
|  | Three Months Ended March 31
|  | 2018 |  | 2017
|  | (in millions of dollars)
Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives |  |  |
Interest Rate Swaps and Forwards | $ | (0.2 | ) |  | $ | — |
Foreign Exchange Contracts | 3.8 |  |  | (4.5 | )
| Total | $ | 3.6 |  |  | $ | (4.5 | )
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.
|  | Three Months Ended March 31
|  | 2018 |  | 2017
|  | (in millions of dollars)
Net Realized Investment Gain (Loss) |  |  |
| Credit Default Swaps | $ | — |  |  | $ | (0.3 | )
| Foreign Exchange Contracts | 0.7 |  |  | 0.2 |
| Embedded Derivative in Modified Coinsurance Arrangement | (1.7 | ) |  | 8.6 |
| Total | $ | (1.0 | ) |  | $ | 8.5 |

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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 -URI http://asc.fasb.org/topic&trid=2229140 + Details
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