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Derivative Instruments
 6 Months Ended
Jun. 30, 2017
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments
Derivative Instruments
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, presented in the consolidated balance sheets are as follows:
 
June 30, 2017
 
December 31, 2016
 
(Dollars in thousands)
Assets
 
 
 
Derivative instruments
 
 
 
Call options
$
1,086,624

 
$
830,519

Other assets
 
 
 
Interest rate caps
468

 
1,082

 
$
1,087,092

 
$
831,601

Liabilities
 
 
 
Policy benefit reserves - annuity products
 
 
 
Fixed index annuities - embedded derivatives
$
7,552,365

 
$
6,563,288

Other liabilities
 
 
 
Interest rate swap
2,001

 
2,113

 
$
7,554,366

 
$
6,565,401


The changes in fair value of derivatives included in the unaudited consolidated statements of operations are as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
 
(Dollars in thousands)
Change in fair value of derivatives:
 
 
 
 
 
 
 
Call options
$
267,705

 
$
40,394

 
$
654,441

 
$
(30,357
)
Interest rate swap
(549
)
 
(982
)
 
(474
)
 
(3,626
)
Interest rate caps
(336
)
 
(313
)
 
(614
)
 
(983
)
 
$
266,820

 
$
39,099

 
$
653,353

 
$
(34,966
)
Change in fair value of embedded derivatives:
 
 
 
 
 
 
 
Fixed index annuities—embedded derivatives
$
3,676

 
$
199,917

 
$
79,886

 
$
379,632

Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration contracts accounting
171,297

 
84,386

 
319,257

 
170,528

 
$
174,973

 
$
284,303

 
$
399,143

 
$
550,160


The amounts presented as "Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration contracts accounting" represents the total change in the difference between policy benefit reserves for fixed index annuities computed under the derivative accounting standard and the long-duration contracts accounting standard at each balance sheet date, less the change in fair value of our fixed index annuities embedded derivatives that is presented as Level 3 liabilities in Note 2.
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 due to the nonperformance of the counterparties to these call options 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:
 
 
 
 
 
 
June 30, 2017
 
December 31, 2016
Counterparty
 
Credit Rating
(S&P)
 
Credit Rating (Moody's)
 
Notional
Amount
 
Fair Value
 
Notional
Amount
 
Fair Value
 
 
 
 
 
 
(Dollars in thousands)
Bank of America
 
A+
 
A1
 
$
5,020,592

 
$
179,048

 
$
5,958,884

 
$
178,477

Barclays
 
A-
 
A1
 
3,760,675

 
103,317

 
3,441,832

 
89,721

BNP Paribas
 
A
 
A1
 
1,837,242

 
48,330

 
1,199,265

 
19,598

Citibank, N.A.
 
A+
 
A1
 
3,791,993

 
155,815

 
4,038,528

 
97,094

Credit Suisse
 
A
 
A1
 
3,721,586

 
92,577

 
2,130,710

 
44,242

Deutsche Bank
 
A-
 
Baa2
 
—

 
—

 
25,935

 
892

J.P. Morgan
 
A+
 
Aa3
 
1,622,559

 
53,359

 
1,785,583

 
19,645

Morgan Stanley
 
A+
 
A1
 
2,795,503

 
104,024

 
2,543,421

 
64,425

Royal Bank of Canada
 
AA-
 
A1
 
3,167,888

 
104,644

 
3,384,310

 
103,510

SunTrust
 
A-
 
Baa1
 
3,147,079

 
101,690

 
2,375,418

 
72,990

Wells Fargo
 
AA-
 
Aa2
 
3,986,928

 
131,676

 
3,850,842

 
130,545

Exchange traded
 
 
 
 
 
407,302

 
12,144

 
313,354

 
9,380

 
 
 
 
 
 
$
33,259,347

 
$
1,086,624

 
$
31,048,082

 
$
830,519


As of June 30, 2017 and December 31, 2016, we held $1.1 billion and $0.8 billion, 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 $16.9 million and $55.5 million at June 30, 2017 and December 31, 2016, 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.
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 in our Annual Report on Form 10-K for the year ended December 31, 2016 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 unaudited consolidated statements of operations.
Details regarding the interest rate swap are as follows:
 
 
Notional
 
 
 
Pay
 
 
 
June 30, 2017
 
December 31, 2016
Maturity Date
 
Amount
 
Receive Rate
 
Rate
 
Counterparty
 
Fair Value
 
Fair Value
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
March 15, 2021
 
$
85,500

 
LIBOR
 
2.415
%
 
SunTrust
 
$
(2,001
)
 
$
(2,113
)

Details regarding the interest rate caps are as follows:
 
 
Notional
 
 
 
Cap
 
 
 
June 30, 2017
 
December 31, 2016
Maturity Date
 
Amount
 
Floating Rate
 
Rate
 
Counterparty
 
Fair Value
 
Fair Value
 
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
July 7, 2021
 
$
40,000

 
LIBOR
 
2.50
%
 
SunTrust
 
$
233

 
$
542

July 8, 2021
 
12,000

 
LIBOR
 
2.50
%
 
SunTrust
 
70

 
163

July 29, 2021
 
27,000

 
LIBOR
 
2.50
%
 
SunTrust
 
165

 
377

 
 
$
79,000

 
 
 
 
 
 
 
$
468

 
$
1,082


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. As of June 30, 2017, we deposited $1.8 million of collateral with the counterparty to the swap.