Derivative Instruments

We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. None of our derivatives qualify for hedge accounting, thus, any change in the fair value of the derivatives is recognized immediately in the consolidated statements of operations. The fair value of our derivative instruments, including derivative instruments embedded in fixed index annuity contracts and derivative instruments embedded in a convertible debt issue, presented in the consolidated balance sheets are as follows:



	December 31,
	2014		2013
	(Dollars in thousands)
Assets
Derivative instruments
Call options	$	731,113	$	856,050
Other assets
2015 notes hedges	30,291		107,041
Interest rate caps	2,778		6,103
Interest rate swap	—		712
	$	764,182	$	969,906
Liabilities
Policy benefit reserves—annuity products
Fixed index annuities—embedded derivatives	$	5,574,653	$	4,406,163
Other liabilities
2015 notes embedded conversion derivative (see Note 9)	30,291		107,041
Interest rate swap	2,644		—
	$	5,607,588	$	4,513,204

The changes in fair value of derivatives included in the consolidated statements of operations are as follows:



	Year Ended December 31,
	2014			2013			2012
	(Dollars in thousands)
Change in fair value of derivatives:
Call options	$	521,947		$	932,003		$	228,610
2015 notes hedges	(8,934		)	145,751			(2,488		)
2015 warrants	—			(9,568		)	—
Interest rate swap	(4,863		)	4,973			(4,261		)
Interest rate caps	(3,325		)	2,856			(723		)
	$	504,825		$	1,076,015		$	221,138
Change in fair value of embedded derivatives:
Fixed index annuities—embedded derivatives	$	47,548		$	(8,006	)	$	289,387
2015 notes embedded conversion derivative (see Note 9)	(19,036		)	141,974			(2,488		)
2029 notes embedded conversion derivative (see Note 9)	3,809			—			—
	$	32,321		$	133,968		$	286,899

We have fixed index annuity products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the gain in a specified market index. When fixed index annuity deposits are received, a portion of the deposit is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to fixed index annuity policyholders. Substantially all such call options are one year options purchased to match the funding requirements of the underlying policies. The call options are marked to fair value with the change in fair value included as a component of revenues. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and we purchase new one-year call options to fund the next annual index credit. We manage the cost of these purchases through the terms of our fixed index annuities, which permit us to change caps, participation rates, and/or asset fees, subject to guaranteed minimums on each policy's anniversary date. By adjusting caps, participation rates, or asset fees, we can generally manage option costs except in cases where the contractual features would prevent further modifications.

Our strategy attempts to mitigate any potential risk of loss under these agreements through a regular monitoring process which evaluates the program's effectiveness. We do not purchase call options that would require payment or collateral to another institution and our call options do not contain counterparty credit-risk-related contingent features. We are exposed to risk of loss in the event of nonperformance by the counterparties and, accordingly, we purchase our option contracts from multiple counterparties and evaluate the creditworthiness of all counterparties prior to purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a Standard and Poor's credit rating of A- or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration limits. We also have credit support agreements that allow us to request the counterparty to provide collateral to us when the fair value of our exposure to the counterparty exceeds specified amounts.

The notional amount and fair value of our call options by counterparty and each counterparty's current credit rating are as follows:



			December 31,
			2014				2013
Counterparty	Credit Rating (S&P)	Credit Rating (Moody's)	Notional Amount		Fair Value		Notional Amount		Fair Value
			(Dollars in thousands)
Bank of America	A	A2	$	2,114,812	$	62,932	$	1,683,911	$	73,836
Barclays	A	A2	4,083,259		135,609		2,396,839		113,513
BNP Paribas	A+	A1	1,321,136		42,644		1,382,661		38,849
Citibank, N.A.	A	A2	3,190,204		96,759		1,536,547		72,310
Credit Suisse	A	A1	2,354,811		75,381		4,060,352		193,304
Deutsche Bank	A	A3	2,682,960		64,028		747,587		41,074
HSBC	AA-	A1	38,599		1,767		200,011		10,518
J.P. Morgan	A+	Aa3	401,804		13,488		786,429		36,863
Morgan Stanley	A-	Baa2	2,605,687		77,106		3,546,487		150,437
Royal Bank of Canada	AA-	Aa3	1,364,362		41,717		714,941		25,140
SunTrust	BBB+	A3	248,622		5,405		—		—
Wells Fargo	AA-	Aa3	3,550,188		114,277		2,221,874		100,206
			$	23,956,444	$	731,113	$	19,277,639	$	856,050

As of December 31, 2014 and 2013, we held $743.0 million and $818.2 million, respectively, of cash and cash equivalents and other securities from counterparties for derivative collateral, which is included in other liabilities on our consolidated balance sheets. This derivative collateral limits the maximum amount of economic loss due to credit risk that we would incur if parties to the call options failed completely to perform according to the terms of the contracts to $47.4 million and $71.7 million at December 31, 2014 and 2013, respectively.

The future annual index credits on our fixed index annuities are treated as a "series of embedded derivatives" over the expected life of the applicable contract. We do not purchase call options to fund the index liabilities which may arise after the next policy anniversary date. We must value both the call options and the related forward embedded options in the policies at fair value. During the year ended December 31, 2014, we revised future period assumptions for lapse rates and the expected costs of annual call options used in determining fixed index annuity embedded derivatives. These revisions decreased the change in fair value of embedded derivatives for the year ended December 31, 2014 by $62.6 million, which after related adjustments to deferred sales inducements and deferred policy acquisition costs and income taxes, increased net income by $14.8 million.

We entered into an interest rate swap and interest rate caps to manage interest rate risk associated with the floating rate component on certain of our subordinated debentures. See Note 10 for more information on our subordinated debentures. The terms of the interest rate swap provide that we pay a fixed rate of interest and receive a floating rate of interest. The terms of the interest rate caps limit the three month London Interbank Offered Rate ("LIBOR") to 2.50%. The interest rate swap and caps are not effective hedges under accounting guidance for derivative instruments and hedging activities. Therefore, we record the interest rate swap and caps at fair value and any net cash payments received or paid are included in the change in fair value of derivatives in the consolidated statements of operations.

Details regarding the interest rate swap are as follows:



						December 31,
						2014			2013
Maturity Date	Notional Amount		Receive Rate	Pay Rate	Counterparty	Fair Value			Fair Value
						(Dollars in thousands)
March 15, 2021	$	85,500	LIBOR	2.415%	SunTrust	$	(2,644	)	$	712

Details regarding the interest rate caps are as follows:



						December 31,
						2014		2013
Maturity Date	Notional Amount		Floating Rate	Cap Rate	Counterparty	Fair Value		Fair Value
						(Dollars in thousands)
July 7, 2021	$	40,000	LIBOR	2.50%	SunTrust	$	1,398	$	3,073
July 8, 2021	12,000		LIBOR	2.50%	SunTrust	420		923
July 29, 2021	27,000		LIBOR	2.50%	SunTrust	960		2,107
	$	79,000				$	2,778	$	6,103

The interest rate swap converts floating rates to fixed rates for seven years which began in March 2014. The interest rate caps cap our interest rates for seven years which began in July 2014.

In September 2010, concurrently with the issuance of $200.0 million principal amount of 3.50% Convertible Senior Notes due September 15, 2015 (the "2015 notes"), we entered into hedge transactions (the "2015 notes hedges") with two counterparties whereby we would receive the cash equivalent of the conversion spread on 16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the 2015 notes. The number of shares and strike price of the 2015 notes hedges are subject to adjustment based on dividends we pay subsequent to their purchase. The 2015 notes hedges expire on September 15, 2015, and must be settled in cash. The 2015 notes hedges are accounted for as derivative assets and are included in other assets in our consolidated balance sheets. The 2015 notes hedges and 2015 notes embedded conversion derivative are adjusted to fair value each reporting period and unrealized gains and losses are reflected in our consolidated statements of operations.

In separate transactions, we sold warrants (the "2015 warrants") to the 2015 notes hedges counterparties for the purchase of up to 16.0 million shares of our common stock at a price of $16.00 per share. We received $15.6 million in cash proceeds from the sale of the 2015 warrants, which was recorded as an increase in additional paid-in capital. The number of shares and strike price of the warrants are subject to adjustment based on dividends we pay subsequent to selling the warrants. The warrants expire on various dates from December 2015 through March 2016 and are intended to be settled in net shares. Changes in the fair value of these warrants will not be recognized in our consolidated financial statements as long as the instruments remain classified as equity.

In 2014, we entered into five separate partial unwind agreements with the counterparties to the 2015 notes hedges and the 2015 warrants to coincide with the extinguishment of a portion of our 2015 notes (see Note 9) whereby we agreed to settle the related 2015 notes hedges and the 2015 warrants and received net cash from the counterparties totaling $16.6 million. The agreements to settle the 2015 warrants in cash required us to reclassify $51.3 million from equity to a derivative liability which represented the fair value of the 2015 warrants committed to the unwind on the day that we entered into the agreements. The fair value of these warrants did not change after reclassification as they were settled in cash at the time the agreements were executed.

In 2013, we entered into three separate partial unwind agreements with the counterparties to the 2015 notes hedges and the 2015 warrants to coincide with the extinguishment of a portion of our 2015 notes (see Note 9) whereby we agreed to settle the related 2015 notes hedges and the 2015 warrants and received net cash from the counterparties totaling $22.2 million. The agreements to settle the 2015 warrants in cash required us to reclassify $48.0 million from equity to a derivative liability which represented the fair value of the 2015 warrants committed to the unwind on the day that we entered into the unwind agreements. Subsequent to the reclassification, we were required to recognize any change in fair value of the 2015 warrants committed to the unwind agreements through net income.

At December 31, 2014, as a result of the partial unwind transactions and cash dividend adjustments, we had 2015 notes hedges and 2015 warrants outstanding on 1.8 million shares of our common stock at strike prices of $12.25 and $15.68 per share, respectively.

The average price of our common stock has exceeded the strike price of the 2015 warrants in each quarter of 2014 and the last two quarters of 2013 and the dilutive effect of the 2015 warrants has been included in diluted earnings per share for the years ended December 31, 2014 and 2013. The 2015 warrants were not dilutive for the year ended December 31, 2012.