Derivative Instruments

9 Months Ended

Sep. 30, 2021

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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:


	September 30, 2021		December 31, 2020
	(Dollars in thousands)
Assets
Derivative instruments
Call options	$	988,835	$	1,310,954
Warrants	1,198		—
	$	990,033	$	1,310,954

Liabilities
Policy benefit reserves - annuity products
Fixed index annuities - embedded derivatives, net	$	7,547,840	$	7,938,281

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(Dollars in thousands)
Change in fair value of derivatives:
Call options	$	(71,688)	$	205,011	$	825,381	$	(409,263)
Warrants	987		—		1,103		—
Interest rate caps	—		—		—		62
	$	(70,701)	$	205,011	$	826,484	$	(409,201)
Change in fair value of embedded derivatives:
Fixed index annuities - embedded derivatives	$	(681,509)	$	(2,021,513)	$	(932,546)	$	(2,392,600)
Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration contracts accounting	145,105		289,016		387,442		536,977
	$	(536,404)	$	(1,732,497)	$	(545,104)	$	(1,855,623)

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 3.

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 and the changes in fair value for open positions. On the respective anniversary dates of the index policies, the index used to compute the index credit is reset and we purchase new call options to fund the next 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 non-exchange traded 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:


			September 30, 2021				December 31, 2020
Counterparty	Credit Rating (S&P)	Credit Rating (Moody's)	Notional Amount		Fair Value		Notional Amount		Fair Value
			(Dollars in thousands)
Bank of America	A+	Aa2	$	2,994,366	$	61,336	$	2,835,420	$	95,378
Barclays	A	A1	4,525,383		145,696		5,710,978		277,692
Canadian Imperial Bank of Commerce	A+	Aa2	5,342,067		188,902		6,593,815		279,053
Citibank, N.A.	A+	Aa3	3,296,027		72,818		3,118,979		96,757
Credit Suisse	A+	A1	4,581,898		102,878		4,422,798		78,823
J.P. Morgan	A+	Aa2	3,833,032		47,527		3,600,636		54,762
Morgan Stanley	A+	Aa3	1,744,800		33,258		2,856,466		62,969
Royal Bank of Canada	AA-	A2	2,640,076		58,383		1,289,699		32,753
Societe Generale	A	A1	2,638,886		60,749		1,494,904		34,394
Truist	A	A2	2,040,196		58,879		2,375,124		96,573
Wells Fargo	A+	Aa2	5,713,233		152,124		4,848,541		196,801
Exchange traded			283,983		6,285		214,819		4,999
			$	39,633,947	$	988,835	$	39,362,179	$	1,310,954

As of September 30, 2021 and December 31, 2020, we held $1.1 billion and $1.3 billion, respectively, of cash and cash equivalents and other investments 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 $6.3 million and $35.1 million at September 30, 2021 and December 31, 2020, respectively.

The future 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, 2020 for more information on our subordinated debentures. As of September 30, 2021, all of our floating rate subordinated debentures have been redeemed and the interest rate swap and interest rate caps have been terminated. The terms of the interest rate swap provided that we paid a fixed rate of interest and received a floating rate of interest. The terms of the interest rate caps limited the three month LIBOR to 2.50%. The interest rate swap and caps were not effective hedges under accounting guidance for derivative instruments and hedging activities. Therefore, we recorded the interest rate swap and caps at fair value and any net cash payments received or paid were included in the change in fair value of derivatives in the unaudited consolidated statements of operations.