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FORTITUDE LIFE INSURANCE & ANNUITY CO – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following analysis of our financial condition and results of
operations in conjunction with the "Forward-Looking Statements" included below
the Table of Contents, "Risk Factors", and the Financial Statements included in
this Annual Report on Form 10-K.
Overview
The Company was established in 1969 and has been a provider of annuity contracts
for the individual market in the United States . The Company's products have been
sold primarily to individuals to provide for long-term savings and retirement
needs and to address the economic impact of premature death, estate planning
concerns and supplemental retirement income.
The Company has sold a wide array of annuities, including deferred and immediate
variable and index-linked annuities. Some of our annuity products include (1)
fixed interest rate allocation options, subject to a market value adjustment,
that are registered with the United States Securities and Exchange Commission
(the "SEC"), or (2) fixed-rate allocation options subject to a limited market
value adjustment or no market value adjustment and not registered with the SEC .
The Company has ceased offering new products and has ceased offering new
contracts for existing products, although it may decide to begin offering new
products or contracts in the future. For more information on products, see "Item
1 Business - Products".
Prior to April 1, 2022 , the Company was a wholly-owned subsidiary of Prudential
Annuities, Inc ("PAI"), an indirect wholly-owned subsidiary of Prudential
Financial, Inc. ("Prudential Financial"). On April 1, 2022 , PAI completed the
sale of its equity interest in the Company to FGH. As a result, the Company is
no longer an affiliate of Prudential Financial or any of its affiliates.
Following the acquisition of FLIAC, purchase accounting was applied to FGH's
financial statements and we have elected to"push down" the basis to FLIAC in
accordance with Accounting Standards Codification ("ASC") 805, Business
Combinations. The application of pushdown accounting created a new basis of
accounting for all assets and liabilities based on fair value at the date of
acquisition. As a result, FLIAC's financial position, results of operations, and
cash flows subsequent to the acquisition are not comparable with those prior to
April 1, 2022 , and therefore have been segregated to indicate pre-acquisition
and post-acquisition periods. The pre-acquisition period through March 31, 2022
is referred to as the Predecessor Company . The post-acquisition period, April 1,
2022 and forward, includes the impact of pushdown accounting and is referred to
as the Successor Company .
Novation of Ceded Business
In the second quarter of 2022, in accordance with applicable state law, a
program was instituted to novate a significant portion of the Ceded Business
policies from FLIAC to Pruco Life Insurance Company ("Pruco Life"). The program
does not have an impact on stockholders' equity or net income but has resulted
in the reduction of certain activity/balances associated with these policies.
During the nine months ended December 31, 2022 , approximately $6.7 billion of
account value, which generally approximates fair values of insurance
liabilities, was transferred out of the Company as a result of the novation
program, which represents approximately 66 percent of account value since the
acquisition of the Company on April 1, 2022 .
Predecessor Company Reinsurance Transactions
Effective
contracts, along with the living benefit guarantees, from Pruco Life, excluding
the
coinsurance and modified coinsurance agreement. This reinsurance agreement
covered new and in-force business and excluded business reinsured externally.
EffectiveJuly 1, 2021 , Pruco Life recaptured the risks related to its business, as discussed above, that had previously been reinsured to the Company fromApril 1, 2016 throughJune 30, 2021 . The product risks related to the previously reinsured 27 -------------------------------------------------------------------------------- Table of Contents business that were being managed in the Company, were transferred to Pruco Life. In addition, management of the living benefit hedging program related to the previously reinsured living benefit riders, which was being managed in the Company, was transferred to Pruco Life. This transaction is referred to as the "2021 Variable Annuities Recapture". See Note 19 to the Financial Statements included in Item 8, for more details. EffectiveDecember 1, 2021 , the Company entered into a reinsurance agreement with Pruco Life under which the Company reinsured certain of its variable and fixed indexed annuities and fixed annuities with a guaranteed lifetime withdrawal income feature to Pruco Life.
Banking Receiverships
Recently, inMarch 2023 , multiple banks (such asSilicon Valley Bank and Signature Bank) were placed into receivership or acquired by another bank pursuant to theFederal Deposit Insurance Corporation's regulatory authority. As of the date of the filing of this Annual Report on Form 10-K, we did not have cash deposits or direct equity or fixed income general account investments in these banks. See "Risk Factors" for further discussion.
COVID-19
Since the first quarter of 2020, the COVID-19 pandemic has at times caused extreme stress and disruption in the global economy and financial markets and elevated mortality and morbidity for the global population. The COVID-19 pandemic impacted our results of operations in prior periods and may impact our results of operations in future periods. The Company has taken several measures to manage the impacts of this crisis.
•Results of Operations. See "Results of Operations" for a discussion of results.
•Risk Factors. See "Risk Factors" for a discussion of the risks to our
businesses posed by the COVID-19 pandemic.
Revenues and Expenses
The Company earns revenues principally from contract fees, mortality and expense fees, and asset administration fees from annuity and investment products, all of which primarily result from the sale and servicing of annuity products. The Company also earns net investment income from the investment of general account and other funds. The Company's operating expenses principally consist of annuity benefit guarantees provided, reserves established for anticipated future annuity benefit guarantees, and costs of managing risk related to these products. The Company's operating expenses also include interest credited to policyholders' account balances, general business expenses, reinsurance premiums, and commissions and other costs of selling and servicing the various products it sold.
Impact of a Changing Interest Rate Environment
As a financial services company, market interest rates are a key driver of the Company's results of operations and financial condition. Changes in interest rates can affect our results of operations and/or our financial condition in several ways, including favorable or adverse impacts to: • investment-related activity, including: investment income returns, net interest margins, net investment spread results, new money rates, mortgage loan prepayments and bond redemptions; • the recoverability of deferred tax assets related to losses on our fixed maturity securities portfolio; • hedging costs and other risk mitigation activities; • insurance reserve levels and market experience true-ups; • customer account values, including their impact on fee income; •product offerings, design features, crediting rates and sales mix; and •policyholder behavior, including surrender or withdrawal activity.
For more information on interest rate risks, see "Risk Factors - Market Risk".
Accounting Policies & Pronouncements
Application of Critical Accounting Estimates
The preparation of financial statements in conformity with generally accepted accounting principles inthe United States of America ("U.S. GAAP") requires the application of accounting policies that often involve a significant degree of judgment. Management, on an ongoing basis, reviews estimates and assumptions used in the preparation of financial statements. If management determines that modifications in assumptions and estimates are appropriate given current facts and circumstances, 28 -------------------------------------------------------------------------------- Table of Contents the Company's results of operations and financial position as reported in the Financial Statements could change significantly. The following sections discuss the accounting policies applied in preparing theSuccessor Company andPredecessor Company financial statements that management believes are/were most dependent on the application of estimates and assumptions and require management's most difficult, subjective or complex judgments. Following the acquisition of FLIAC by FGH onApril 1, 2022 , certain accounting policies utilized by thePredecessor Company have either been updated or are no longer applicable. In particular, Deferred Policy Acquisition Costs ("DAC"), Deferred Sales Inducements ("DSI"), and Value of Business Acquired ("VOBA") were fully written off subsequent to acquisition due to our application of push-down accounting. We have included discussion regarding these Insurance Assets under "Predecessor Company " below but do not consider them critical accounting estimates subsequent to acquisition.
SUCCESSOR COMPANY
INSURANCE LIABILITIES
The fair values of insurance liabilities are calculated as the present value of future expected benefit payments to customers, anticipated future trail commissions paid to agents and certain administrative expenses less the present value of future expected rider fees, mortality and expense charges, contract charges and the anticipated future reimbursement of certain asset management fees. This methodology could result in either a liability or asset balance, given changing capital market conditions and various actuarial assumptions. Since there is no observable active market for the transfer of these obligations, the valuations are calculated using internally developed models with option pricing techniques. The models are based on a risk neutral valuation framework and incorporate premiums for risks inherent in valuation techniques, inputs, and the general uncertainty around the timing and amount of future cash flows. The determination of these risk premiums requires the use of management's judgment. The significant inputs to the valuation models include capital market assumptions, such as interest rate levels and volatility assumptions, as well as actuarially-determined assumptions, including contractholder behavior, such as lapse rates, benefit utilization rates, withdrawal rates, and mortality rates. Further information regarding these assumptions are below: The following table summarizes the impact that could result on our insurance liabilities, which are recorded at fair value, from changes in certain key assumptions. The information below is for illustrative purposes and includes only the immediate hypothetical direct impact onDecember 31, 2022 balances of changes in a single assumption and not changes in any combination of assumptions. Additionally, the illustration of the insurance assumption impacts below reflects a parallel shift in the insurance assumptions; however, these may be non-parallel in practice. Changes in current assumptions could result in impacts to financial statement balances that are in excess of the amounts illustrated. The impacts presented within this table exclude the related impacts of our asset/liability management strategy, which seeks to offset the changes in the balances presented within this table and is primarily composed of investments and derivatives. 29
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December 31, 2022
Insurance
Liabilities
(in millions)
Hypothetical change in insurance liabilities due to changes in
actuarially-determined assumptions
Mortality
Increase by 1% $ (21)
Decrease by 1% $ 21
Lapse
Increase by 10% $ (37)
Decrease by 10% $ 38
Hypothetical change in insurance liabilities due to changes in capital market
conditions
NPR credit spread
Increase by 50 basis points $ (269)
Decrease by 50 basis points $ 299
Equity Market Shock
Increase by 10% $ (336)
Decrease by 10% $ 367
Interest Rate Shock
Increase by 100 basis points $ (754)
Decrease by 100 basis points $ 948
Equity Volatility
Increase by 1% $ 9
Decrease by 1% $ (9)
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The assumptions used in establishing our insurance liabilities are generally based on the Company's experience, industry experience, and/or other factors, as applicable. We evaluate our actuarial assumptions quarterly and update as appropriate. Generally, we do not expect trends to change significantly in the short-term and, to the extent these trends may change, we expect such changes to be gradual over the long-term. See Note 7 Insurance Liabilities within "Item 8 Financial Statements and Supplementary Data" for further discussion regarding the significant assumptions noted above as well as certain other significant assumptions not included in the above analysis.
VALUATION OF INVESTMENTS
Our investment portfolio consists of public and private fixed maturity
securities, mortgage and other loans, equity securities, other invested assets,
and derivative financial instruments. Derivatives are financial instruments
whose values are derived from interest rates, foreign exchange rates, financial
indices or the values of securities. Derivative financial instruments we
generally use include swaps, futures, forwards and options and may be
exchange-traded or contracted in the over-the-counter ("OTC") market.
We present at fair value in the statements of financial position our fixed
maturity and equity securities, certain investments within "Other invested
assets," such as derivatives and the majority of our private equity partnership
investments. For additional information regarding the key estimates and
assumptions surrounding the determination of fair value of fixed maturity and
equity securities, as well as derivative instruments, and other investments, see
Note 6 to the Financial Statements.
The degree of judgment utilized in measuring the fair value of financial
instruments generally correlates to the level of pricing observability.
Financial instruments with readily available active quoted prices or for which
fair value can be measured from actively quoted prices in active markets
generally have more pricing observability and less judgment utilized in
measuring fair value. The market sources from which we obtain or derive the fair
values of our assets and liabilities carried at market value include quoted
market prices for actual trades, price quotes from third party pricing vendors,
price quotes we obtain from outside brokers, discounted cash flow, and
observable prices for similar publicly traded or privately traded issues that
incorporate the credit quality and industry sector of the issuer. Our fair value
measurements could differ significantly based on the valuation technique and
available inputs.
Inputs to valuation techniques refer broadly to the assumptions that market
participants use in pricing assets or liabilities, including assumptions about
risk, for example, the risk inherent in a particular valuation technique used to
measure fair value and/or the risk inherent in the inputs to the valuation
technique. We use observable and unobservable inputs in measuring the fair value
of our financial instruments. Observable inputs are inputs that reflect the
assumptions market participants would use in pricing the asset or liability
developed based on market data obtained from independent sources. Unobservable
inputs are developed based on the best information available in the
circumstances, and reflect our evaluation of the assumptions market participants
would use in pricing the asset or liability.
Certain of our investments do not have readily determinable market prices and/or
observable inputs or may at times be affected by the lack of market liquidity.
For these securities, we use internally prepared valuations, including
valuations based on estimates of future profitability, to estimate the fair
value. Additionally, we may obtain prices from independent third-party brokers
to aid in establishing valuations for certain of these securities. Key
assumptions used by us to determine fair value for these securities include
risk-free interest rates, risk premiums, performance of underlying collateral
(if any), and other factors involving significant assumptions which may or may
not reflect those of an active market.
INCOME TAX
Our effective tax rate is based on income, non-taxable and non-deductible items, tax credits, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate. Inherent in determining our annual tax rate are judgments regarding business plans, planning opportunities, and expectations about future outcomes. The primary driver for the difference between theSuccessor Company's effective tax rate and the federal statutory rate is the valuation allowance established during 2022 and the impact of non-taxable investment income associated with the Dividends Received Deduction ("DRD") underU.S. tax law.
Valuation Allowance on Deferred Tax Assets
During 2022, the Company established a valuation allowance of$37 million with respect to realized and unrealized capital losses on our fixed maturity securities portfolio. A portion of the deferred tax asset relates to unrealized capital losses for which 31
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the carryforward period has not yet begun, and as such, when assessing its
recoverability, we consider our ability and intent to hold the underlying
securities to recovery, otherwise a valuation allowance is established.
The evaluation of the recoverability of our deferred tax asset and the need for a valuation allowance requires us to weigh all positive and negative evidence to reach a conclusion that it is more likely than not that all or some portion of the deferred tax asset will not be realized. The weight given to the evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed.
In evaluating the need for a valuation allowance, the Company considers many
factors, including:
(1) the nature of the deferred tax assets and liabilities; (2) whether they are ordinary or capital; (3) the timing of their reversal; (4) taxable income in prior carryback years; (5) projected taxable earnings exclusive of reversing temporary differences and carryforwards; (6) the length of time that carryovers can be utilized; (7) any unique tax rules that would impact the utilization of the deferred tax assets; and (8) any tax planning strategies that the Company would employ to avoid a tax benefit from expiring unused.
Although realization is not assured, management believes it is more likely than
not that the deferred tax assets, net of valuation allowances, will be realized.
Dividends Received Deduction
The DRD is an estimate that incorporates the prior and current year information,
as well as the current year's equity market performance. Both the current
estimate of the DRD and the DRD in future periods can vary based on factors such
as, but not limited to, changes in the amount of dividends received that are
eligible for the DRD, changes in the amount of distributions received from
underlying fund investments, changes in the account balances of variable life
and annuity contracts, and the Company's taxable income before the DRD.
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Table of Contents PREDECESSOR COMPANY INSURANCE ASSETS
Deferred Policy Acquisition Costs and Deferred Sales Inducements
We capitalize costs that are directly related to the acquisition of annuity contracts. These costs primarily include commissions, as well as costs of policy issuance and underwriting and certain other expenses that are directly related to successfully negotiated contracts. We have also deferred costs associated with sales inducements offered in the past related to our variable and fixed annuity contracts. Sales inducements are amounts that are credited to the policyholders' account balances mainly as an inducement to purchase the contract. For additional information about sales inducements, see Note 21 to the Financial Statements. We generally amortize DAC and DSI over the expected lives of the contracts, based on our estimates of the level and timing of gross profits. As described in more detail below, in calculating DAC and DSI amortization we are required to make assumptions about investment returns, mortality, persistency, and other items that impact our estimates of the level and timing of gross profits. We also periodically evaluate the recoverability of our DAC and DSI. For certain contracts, this evaluation is performed as part of our premium deficiency testing, as discussed further below in "Insurance Liabilities-Future Policy Benefits". As ofDecember 31, 2021 , DAC and DSI were$567 million and$295 million , respectively.
Amortization methodologies
We generally amortize DAC and other costs over the expected life of the policies in proportion to total gross profits. Total gross profits include both actual gross profits and estimates of gross profits for future periods. Gross profits are defined as (i) amounts assessed for mortality, contract administration, surrender charges, and other assessments plus amounts earned from investment of policyholder balances, less (ii) benefits in excess of policyholder balances, costs incurred for contract administration, the net cost of reinsurance for certain products, interest credited to policyholder balances and other credits. If significant negative gross profits are expected in any periods, the amount of insurance in force is generally substituted as the base for computing amortization.U.S. GAAP gross profits and amortization rates also include the impacts of the embedded derivatives associated with certain of the optional living benefit features of our variable annuity contracts and indexed annuity contracts and related hedging activities. In calculating amortization expense, we estimate the amounts of gross profits that will be included in ourU.S. GAAP results, and utilize these estimates to calculate distinct amortization rates and expense amounts. In addition, in calculating gross profits, we include the profits and losses related to contracts previously issued by the Company that are reported in legal entities other than the Company as a result of, for example, reinsurance agreements with those entities. The Company has extensive transactions and relationships with other entities, including reinsurance agreements, as discussed in Note 8 and Note 20 to the Financial Statements. Incorporating all product-related profits and losses in gross profits produces an amortization pattern representative of the total economics of the products. For a further discussion of the amortization of DAC and other costs, see "Results of Operations -Predecessor Company ". We also regularly evaluate and adjust the related DAC and DSI balances with a corresponding charge or credit to current period earnings for the impact of actual gross profits and changes in our projections of estimated future gross profits on our DAC and DSI amortization rates. Adjustments to the DAC and DSI balances include the impact to our estimate of total gross profits of the annual review of assumptions, our quarterly adjustments for current period experience, and our quarterly adjustments for market performance. Each of these adjustments is further discussed below in "Annual assumptions review and quarterly adjustments".
Value of Business Acquired
In addition to DAC and DSI, we also recognize an asset for value of business acquired, or VOBA, which is an intangible asset that represents an adjustment to the stated value of acquired in-force insurance contract liabilities to present them at fair value, determined as of the acquisition date. VOBA is amortized over the expected life of the acquired contracts using the same methodology and assumptions used to amortize DAC and DSI (see "-Deferred Policy Acquisition Costs and Deferred Sales Inducements" above for additional information). VOBA is also subject to recoverability testing. As ofDecember 31, 2021 , VOBA was$28 million . 33 -------------------------------------------------------------------------------- Table of Contents Annual assumptions review and quarterly adjustments We perform an annual comprehensive review of the assumptions used in estimating gross profits for future periods. Over the last several years, the Company's most significant assumption updates that have resulted in a change to expected future gross profits and the amortization of DAC, DSI and VOBA have been related to lapse and other contractholder behavior assumptions, mortality, and revisions to expected future rates of returns on investments. These assumptions may also cause potential significant variability in amortization expense in the future. The impact on our results of operations of changes in these assumptions can be offsetting and we are unable to predict their movement or offsetting impact over time. The quarterly adjustments for current period experience referred to above reflect the impact of differences between actual gross profits for a given period and the previously estimated expected gross profits for that period. To the extent each period's actual experience differs from the previous estimate for that period, the assumed level of total gross profits may change. In these cases, we recognize a cumulative adjustment to all previous periods' amortization, also referred to as an experience true-up adjustment. The quarterly adjustments for market performance referred to above reflect the impact of changes to our estimate of total gross profits to reflect actual fund performance and market conditions. A significant portion of gross profits for our variable annuity contracts is dependent upon the total rate of return on assets held in separate account investment options. This rate of return influences the fees we earn on variable annuity contracts, costs we incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts, as well as other sources of profit. Returns that are higher than our expectations for a given period produce higher than expected account balances, which increase the future fees we expect to earn on variable annuity contracts and decrease the future costs we expect to incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts. The opposite occurs when returns are lower than our expectations. The changes in future expected gross profits are used to recognize a cumulative adjustment to all prior periods' amortization. The weighted average rate of return assumptions used in developing estimated market returns consider many factors specific to each product type, including asset durations, asset allocations and other factors. With regard to equity market assumptions, the near-term future rate of return assumption used in evaluating DAC, DSI and VOBA and liabilities for future policy benefits for certain of our products, primarily our domestic variable annuity products, is generally updated each quarter and is derived using a reversion to the mean approach, a common industry practice. Under this approach, we consider historical equity returns and adjust projected equity returns over an initial future period of five years (the "near-term") so that equity returns converge to the long-term expected rate of return. If the near-term projected future rate of return is greater than our near-term maximum future rate of return of 15.0%, we use our maximum future rate of return. If the near-term projected future rate of return is lower than our near-term minimum future rate of return of 0%, we use our minimum future rate of return. With regard to interest rate assumptions used in evaluating DAC, DSI and liabilities for future policy benefits for certain of our products, we generally update the long-term and near-term future rates used to project fixed income returns annually and quarterly, respectively. As a result of our 2021 annual reviews and update of assumptions and other refinements, we kept our long-term expectation of the 10-yearU.S. Treasury rate unchanged and continue to grade to a rate of 3.25% over ten years. As part of our quarterly market experience updates, we update our near-term projections of interest rates to reflect changes in current rates. 34
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Table of Contents INSURANCE LIABILITIES Future Policy Benefits
Future Policy Benefit Reserves
We establish reserves for future policy benefits to, or on behalf of,
policyholders, using methodologies prescribed by
methodologies used include the following:
•For life contingent payout annuities, we utilize a net premium valuation
methodology in measuring the liability for future policy benefits. Under this
methodology, a liability for future policy benefits is accrued when premium
revenue is recognized. The liability, which represents the present value of
future benefits to be paid to or on behalf of policyholders and related expenses
less the present value of future net premiums (portion of the gross premium
required to provide for all benefits and expenses), is estimated using methods
that include assumptions applicable at the time the insurance contracts are made
with provisions for the risk of adverse deviation, as appropriate. Original
assumptions continue to be used in subsequent accounting periods to determine
changes in the liability for future policy benefits (often referred to as the
"lock-in concept"), unless a premium deficiency exists. The result of the net
premium valuation methodology is that the liability at any point in time
represents an accumulation of the portion of premiums received to date expected
to be needed to fund future benefits (i.e., net premiums received to date), less
any benefits and expenses already paid. The liability does not necessarily
reflect the full policyholder obligation the Company expects to pay at the
conclusion of the contract since a portion of that obligation would be funded by
net premiums received in the future and would be recognized in the liability at
that time. We perform premium deficiency tests using best estimate assumptions
as of the testing date without provisions for adverse deviation. If the
liabilities determined based on these best estimate assumptions are greater than
the net reserves (i.e., GAAP reserves net of any DAC, DSI or VOBA asset), the
existing net reserves are adjusted by first reducing these assets by the amount
of the deficiency or to zero through a charge to current period earnings. If the
deficiency is more than these asset balances for insurance contracts, we then
increase the net reserves by the excess, again through a charge to current
period earnings. If a premium deficiency is recognized, the assumptions as of
the premium deficiency test date are locked-in and used in subsequent valuations
and the net reserves continue to be subject to premium deficiency testing. In
addition, for limited-payment contracts, future policy benefit reserves also
include a deferred profit liability representing gross premiums received in
excess of net premiums. The deferred profits are generally recognized in revenue
in a constant relationship with insurance in force or with the amount of
expected future benefit payments.
•For certain contract features, such as those related to guaranteed minimum
death benefits ("GMDB") and guaranteed minimum income benefits ("GMIB"), a
liability is established when associated assessments (which include policy
charges for administration, mortality, expense, surrender, and other, regardless
of how characterized) are recognized. This liability is established using
current best estimate assumptions and is based on the ratio of the present value
of total expected excess payments (e.g., payments in excess of account value)
over the life of the contract divided by the present value of total expected
assessments (i.e., benefit ratio). The liability equals the current benefit
ratio multiplied by cumulative assessments recognized to date, plus interest,
less cumulative excess payments to date. The result of the benefit ratio method
is that the liability at any point in time represents an accumulation of the
portion of assessments received to date expected to be needed to fund future
excess payments, less any excess payments already paid. The liability does not
necessarily reflect the full policyholder obligation the Company expects to pay
at the conclusion of the contract since a portion of that excess payment would
be funded by assessments received in the future and would be recognized in the
liability at that time. Similar to as described above for DAC, the reserves are
subject to adjustments based on annual reviews of assumptions and quarterly
adjustments for experience, including market performance. These adjustments
reflect the impact on the benefit ratio of using actual historical experience
from the issuance date to the balance sheet date plus updated estimates of
future experience. The updated benefit ratio is then applied to all prior
periods' assessments to derive an adjustment to the reserve recognized through a
benefit or charge to current period earnings.
•For certain product guarantees, primarily certain optional living benefit
features of the variable annuity products including guaranteed minimum
accumulation benefits ("GMAB"), guaranteed minimum withdrawal benefits ("GMWB")
and guaranteed minimum income and withdrawal benefits ("GMIWB"), the benefits
are accounted for as embedded derivatives using a fair value accounting
framework. The fair value of these contracts is calculated as the present value
of expected future benefit payments to contractholders less the present value of
assessed rider fees attributable to the embedded derivative feature. Under U.S.
GAAP, the fair values of these benefit features are based on assumptions a
market participant would use in valuing these embedded derivatives. Changes in
the fair value of the embedded derivatives are recorded quarterly through a
benefit or charge to current period earnings. For additional information
regarding the valuation of these embedded derivatives, see Notes 6 and 17 to the
Financial Statements.
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The assumptions used in establishing reserves are generally based on the
Company's experience, industry experience and/or other factors, as applicable.
We update our actuarial assumptions, such as mortality and policyholder behavior
assumptions annually, unless a material change is observed in an interim period
that we feel is indicative of a long-term trend. Generally, we do not expect
trends to change significantly in the short-term and, to the extent these trends
may change, we expect such changes to be gradual over the long-term.
The following paragraphs provide additional details about the reserves we have
established:
The reserves for future policy benefits of our business relate to reserves for
the GMDB and GMIB features of our variable annuities, and for the optional
living benefit features that are accounted for as embedded derivatives. As
discussed above, in establishing reserves for GMDBs and GMIBs, we utilize
current best estimate assumptions. The primary assumptions used in establishing
these reserves generally include annuitization, lapse, withdrawal and mortality
assumptions, as well as interest rate and equity market return assumptions.
Lapse rates are adjusted at the contract level based on the in-the-moneyness of
the benefit and reflect other factors, such as the applicability of any
surrender charges. Lapse rates are reduced when contracts are more in-the-money.
Lapse rates are also generally assumed to be lower for the period where
surrender charges apply. For life contingent payout annuity contracts, we
establish reserves using best estimate assumptions with provisions for adverse
deviations as of inception or best estimate assumptions as of the most recent
loss recognition date.
The reserves for certain optional living benefit features, including GMAB, GMWB
and GMIWB are accounted for as embedded derivatives at fair value, as described
above. This methodology could result in either a liability or contra-liability
balance, given changing capital market conditions and various actuarial
assumptions. Since there is no observable active market for the transfer of
these obligations, the valuations are calculated using internally-developed
models with option pricing techniques. The models are based on a risk neutral
valuation framework and incorporate premiums for risks inherent in valuation
techniques, inputs, and the general uncertainty around the timing and amount of
future cash flows. The significant inputs to the valuation models for these
embedded derivatives include capital market assumptions, such as interest rate
levels and volatility assumptions, the Company's market-perceived risk of its
own non-performance risk ("NPR"), as well as actuarially determined assumptions,
including mortality rates and contractholder behavior, such as lapse rates,
benefit utilization rates and withdrawal rates. Capital market inputs and actual
contractholders' account values are updated each quarter based on capital market
conditions as of the end of the quarter, including interest rates, equity
markets and volatility. In the risk neutral valuation, the initial swap curve
drives the total returns used to grow the contractholders' account values. The
Company's discount rate assumption is based on the London Inter-Bank Offered
Rate ("LIBOR") swap curve adjusted for an additional spread, which includes an
estimate of NPR . Actuarial assumptions, including contractholder behavior and
mortality, are reviewed at least annually and updated based upon emerging
experience, future expectations and other data, including any observable market
data, such as available industry studies or market transactions such as
acquisitions and reinsurance transactions. For additional information regarding
the valuation of these optional living benefit features, see Note 6 and 17 to
the Financial Statements.
Policyholders' Account Balances
Policyholders' account balances liability represents the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. This liability is primarily associated with the accumulated account deposits, plus interest credited, less policyholder withdrawals and other charges assessed against the account balance, as applicable. The liability also includes provisions for benefits under non-life contingent payout annuities. Policyholders' account balances also include amounts representing the fair value of embedded derivative instruments associated with the index-linked features of certain annuity products. For additional information regarding the valuation of these embedded derivatives, see Note 6 and 17 to the Financial Statements.
Valuation of Investments, Including Derivatives, Measurement of Allowance for
Credit Loss, and the Recognition of Other-than-Temporary Impairments
Our investment portfolio consists of public and private fixed maturity
securities, commercial mortgage and other loans, equity securities, other
invested assets and derivative financial instruments. Derivatives are financial
instruments whose values are derived from interest rates, foreign exchange
rates, financial indices or the values of securities. Derivative financial
instruments we generally use include swaps, futures, forwards and options and
may be exchange-traded or contracted in the over-the-counter ("OTC") market. We
are also party to financial instruments that contain derivative instruments that
are "embedded" in the financial instruments. Management believes the following
accounting policies related to investments, including derivatives, are most
dependent on the application of estimates and assumptions. Each of these
policies is discussed further within other relevant disclosures related to
investments and derivatives, as referenced below:
•Valuation of investments, including derivatives;
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•Measurement of the allowance for credit losses on fixed maturity securities classified as available-for-sale, commercial mortgage loans, and other loans; and
•Recognition of other-than-temporary impairments ("OTTI") for equity method
investments.
We present at fair value in the statements of financial position our debt
security investments classified as available-for-sale, investments classified as
trading, and certain fixed maturities, equity securities, and certain
investments within "Other invested assets," such as derivatives. For additional
information regarding the key estimates and assumptions surrounding the
determination of fair value of fixed maturity and equity securities, as well as
derivative instruments, embedded derivatives and other investments, see Notes 6
and 17 to the Financial Statements.
For our investments classified as available-for-sale, the impact of changes in
fair value is recorded as an unrealized gain or loss in "Accumulated other
comprehensive income (loss)" ("AOCI"), a separate component of equity. For our
investments classified as trading and equity securities, the impact of changes
in fair value is recorded within "Other income (loss)". Our commercial mortgage
and other loans are carried primarily at unpaid principal balances, net of
unamortized deferred loan origination fees and expenses and unamortized premiums
or discounts and a valuation allowance for losses.
In addition, an allowance for credit losses is measured each quarter for
available-for-sale fixed maturity securities, commercial mortgage and other
loans. For additional information regarding our policies regarding the
measurement of credit losses, see Note 14 to the Financial Statements.
For equity method investments, the carrying value of these investments is written down or impaired to fair value when a decline in value is considered to be other-than-temporary. For additional information regarding our OTTI policies, see Note 14 to the Financial Statements.
Adoption of New Accounting Pronouncements
ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, was issued by theFinancial Accounting Standards Board ("FASB"). This update, along with any subsequent amendments associated with this update, are not applicable due to our election to adopt the fair value option on all of our insurance liabilities. CHANGES IN FINANCIAL POSITION - SUCCESSOR COMPANY As previously noted, the Company's financial position subsequent to the acquisition is not comparable with that prior toApril 1, 2022 . As a result, the following discussion regarding changes in the financial position of theSuccessor Company will be based on changes subsequent to the acquisition-date balance sheet as ofApril 1, 2022 .
Retained Business
Assets decreased approximately$5.5 billion from$32.0 billion atApril 1, 2022 to$26.5 billion atDecember 31, 2022 . The decrease was primarily driven by a$5.2 billion decline in separate account assets due to market depreciation resulting mostly from unfavorable equity market performance. Liabilities decreased approximately$5.3 billion from$30.3 billion atApril 1, 2022 to$25.0 billion atDecember 31, 2022 . The decrease was primarily driven by a$5.2 billion decline in separate account liabilities, which corresponds with the decrease in separate account assets discussed above. Equity decreased approximately$0.2 billion from$1.8 billion atApril 1, 2022 to$1.6 billion atDecember 31, 2022 , with a net loss of$286 million offset by an increase in our own-credit risk (OCR) impact on the fair value of insurance liabilities, net of tax, of$111 million reflected in accumulated other comprehensive income.
Ceded Business
Assets decreased$8.1 billion from$13.1 billion atApril 1, 2022 to$5.0 billion atDecember 31, 2022 . The decrease was primarily driven by a$5.3 billion decline in total investments, of which approximately$4.6 billion was attributable to the previously mentioned novations during 2022. The remaining decline in total investments was driven primarily by losses in the fixed maturity securities portfolio resulting from higher interest rates. Also contributing to the decline in assets was a$2.0 37 -------------------------------------------------------------------------------- Table of Contents billion decrease in the deposit asset which moved commensurately with the novation-related decline in the associated insurance liabilities under its fixed indexed annuity reinsurance agreement with Pruco Life. The remaining driver in the decline in assets was a$0.5 billion decrease in separate account assets due to market depreciation resulting mostly from unfavorable equity market performance. Liabilities decreased$8.1 billion from$13.1 billion atApril 1, 2022 to$5.0 billion atDecember 31, 2022 . The decrease was primarily driven by a$7.6 billion decline in the fair value of insurance liabilities, of which approximately$6.7 billion was attributable to the previously mentioned novations during 2022. Also contributing to the decline in the fair value of insurance liabilities were favorable changes in the fair value of insurance liabilities. The remaining driver in the decline in liabilities was a$0.5 billion decrease in separate account liabilities, which corresponds with the decrease in separate account assets discussed above.
There was no equity within our Ceded Business at both
RESULTS OF OPERATIONS - SUCCESSOR COMPANY As previously noted, the Company's results of operations subsequent to the acquisition are not comparable with those prior toApril 1, 2022 . As a result, the following discussion regarding the results of operations of theSuccessor Company will not be compared to previous periods and will be based solely on activity for the period subsequent to the acquisition.
LOSS FROM OPERATIONS BEFORE INCOME TAXES
Nine months ended
Retained Business
The loss from operations before income taxes of$320 million was driven primarily by investment losses in the fixed maturity securities portfolio resulting from higher interest rates and derivatives losses on interest rate swaps which were partially offset by gains on equity options. Also contributing to the overall loss were elevated general, administrative and other expenses driven by acquisition-related expenses that we expect to decline in future periods. Partially offsetting the drivers of the loss from operations before income taxes were favorable policyholder benefits and changes in the fair value of insurance liabilities, policy charges and fee income, asset management and service fees, and net investment income. Ceded Business
There was no impact to the loss from operations before income tax as all
revenues and expenses are ceded back to
REVENUES, BENEFITS, AND EXPENSES
Retained Business
Revenues were$(276) million for the nine months endedDecember 31, 2022 , driven primarily by investment losses in the fixed maturity securities portfolio resulting from higher interest rates and derivatives losses on interest rate swaps which were partially offset by gains on equity options. Partially offsetting the impact of the investment losses were policy charges and fee income, asset management and service fees, and net investment income. Benefits and expenses were$44 million for the nine months endedDecember 31, 2022 and primarily driven by policyholders' benefits offset by the decrease in the fair value of insurance liabilities. Also contributing to benefits and expenses for the period were general, administrative and other expenses driven by acquisition-related expenses that we expect to decline in future periods. Ceded Business As a result of the reinsurance agreements withPrudential Insurance and Pruco Life, revenues, which were comprised primarily of net investment losses, were fully offset by expenses, which were comprised of policyholder benefits and changes in the fair 38 -------------------------------------------------------------------------------- Table of Contents value of insurance liabilities. CHANGES IN FINANCIAL POSITION - PREDECESSOR COMPANY
Total assets decreased
•$2.8 billion decrease in Separate account assets primarily driven by
unfavorable equity market performance and net outflows.
Total liabilities decreased
to
•$0.7 billion decrease in Future policy benefits driven by a decrease in
reserves related to our variable annuity living benefit guarantees due to
widening non-performance risk ("NPR") spreads and rising interest rates.
•$2.8 billion decrease in Separate account liabilities corresponding to the
decrease in Separate account assets, as discussed above.
Total equity decreased$0.4 billion from$1.7 billion atDecember 31, 2021 to$1.3 billion atMarch 31, 2022 , primarily driven by$0.4 billion of unrealized losses on investments driven by rising interest rates reflected in Accumulated other comprehensive income (loss) and a return of capital of$0.3 billion , partially offset by net income of$0.4 billion .
2021 to 2020 Annual Comparison
Total assets decreased
•$10.4 billion decrease in Total investments and Cash and cash equivalents primarily driven by consideration paid related to the 2021 Variable Annuities Recapture and new reinsurance with Pruco Life and dividend distributions; •$3.7 billion decrease in Deferred policy acquisition costs primarily due to the unwinding of assumed costs as part of the 2021 Variable Annuities Recapture and ceding costs as part of the new reinsurance with Pruco Life;
Partially offset by:
•$7.4 billion increase in Reinsurance recoverables driven by the new reinsurance
with Pruco Life; and
•$1.9 billion increase in Other assets driven by the new reinsurance with Pruco
Life.
Total liabilities decreased by
2020
•$14.0 billion decrease in Future policy benefits primarily driven by the 2021 Variable Annuities Recapture and a decrease in reserves related to our variable annuity living benefit guarantees due to favorable equity market performance and rising interest rates; Partially offset by:
•$7.0 billion increase in Reinsurance payables driven by the new reinsurance
with Pruco Life; and
•$2.6 billion increase in Policyholders' account balances primarily driven by
incremental general account product sales.
Total equity decreased$1.0 billion from$2.7 billion atDecember 31, 2020 to$1.7 billion atDecember 31, 2021 , primarily driven by return of capital of$3.8 billion related to the 2021 Variable Annuities Recapture and$1.4 billion due to unrealized losses on investments driven by rising interest rates reflected in Accumulated other comprehensive income/(loss), partially offset by an after-tax net income of$4.1 billion . 39
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RESULTS OF OPERATIONS - PREDECESSOR COMPANY
LOSS FROM OPERATIONS BEFORE INCOME TAXES
Three Months Ended
Income (loss) from operations before income taxes decreased$2 billion from a gain of$2.4 billion for the three months endedMarch 31, 2021 to a gain of$0.4 billion for the three months endedMarch 31, 2022 , primarily driven by: •Realized investment gains (losses), net decrease reflecting prior year's favorable impact related to the portions of ourU.S. GAAP liability beforeNPR , that are excluded from our hedge targets driven by rising interest rates and favorable prior year equity market performance.
2021 to 2020 Annual Comparison
Income (loss) from operations before income taxes increased$10.3 billion from a loss of$4.0 billion in 2020 to a gain of$6.3 billion in 2021. Excluding the impact of our annual reviews and update of assumptions and other refinements, income from operations increased$10.4 billion primarily driven by: •Significant realized investment gains (losses), reflecting a favorable impact related to the 2021 Variable Annuities Recapture and portions of theU.S. GAAP liability beforeNPR , that are excluded from our hedge target driven by favorable equity market performance and rising interest rates.
All Predecessor Company Periods
The following table illustrates the net impact on our results of operations from changes in theU.S. GAAP embedded derivative liability and hedge positions under the Asset Liability Management ("ALM") strategy, and the related amortization of DAC and other costs, for the periods indicated: Three Months Ended March 31 For the Year Ended December 31, 2022 2021 2020 in millions (1)
Change in value of U.S.GAAP liability, pre-
$ 459$ 5,752 $ (5,904) Change in the NPR adjustment 156 (945) 520
Change in fair value of hedge assets, excluding capital hedges(3)
(392) (3,224) 2,077 Change in fair value of capital hedges(4) 39 (900) (921) 2021 Variable Annuities Recapture Impact - 5,142 - Other 218 1,201 1,622 Realized investment gains (losses), net, and related adjustments 480 7,026 (2,606) Market experience updates(5) (57) 180 (96) Charges related to realized investments gains (losses), net (97) (215) 72
Net impact from changes in the
hedge positions, after the impact of
326
(1)Positive amount represents income; negative amount represents a loss. (2)Represents the change in the liability (excludingNPR ) for our variable annuities which is measured utilizing a valuation methodology that is required underU.S. GAAP. This liability includes such items as risk margins which are required byU.S. GAAP but not included in our best estimate of the liability. (3)Represents the changes in fair value of the derivatives utilized to hedge potential claims associated with our variable annuity living benefit guarantees. (4)Represents the changes in fair value of equity derivatives of the capital hedge program intended to protect a portion of the overall capital position of our business against exposure to the equity markets. (5)Represents the immediate impacts in current period results from changes in current market conditions on estimates of profitability. (6)Excludes amounts from the changes in unrealized gains and losses from fixed income instruments recorded in other comprehensive income (versus net income) of$(70) million for the three months endedMarch 31, 2022 and$1,659 million and$1,298 million for the years endedDecember 31, 2021 and 2020, respectively. 40 -------------------------------------------------------------------------------- Table of Contents For the three months endedMarch 31, 2022 , the gain of$326 million was driven by a favorable impact related to theU.S. GAAP liability beforeNPR , net of change in fair value of hedge assets (excluding capital hedge) largely due to rising interest rates. For 2021, the gain of$7.0 billion primarily reflected favorable impacts related to the portions of theU.S. GAAP liability beforeNPR that are excluded from the hedge target driven by rising interest rates and favorable equity markets and the 2021 Variable Annuities Recapture impact, partially offset by changes in fair value of hedge assets and capital hedges driven by rising interest rates and favorable equity markets and unfavorableNPR adjustment. For 2020, the loss of$2.6 billion primarily reflected unfavorable impacts related to the portions of theU.S. GAAP liability beforeNPR that are excluded from the hedge target, partially offset by changes in fair value of hedge assets driven by declining interest rates.
Revenues, Benefits and Expenses
Three Months Ended
Revenues decreased$2.4 billion from a gain of$3.1 billion for the three months endedMarch 31, 2021 to a gain of$0.7 billion for the three months endedMarch 31, 2022 primarily driven by: •Realized investment gains (losses), net decrease reflecting prior year's favorable impact related to the portions of ourU.S. GAAP liability beforeNPR , that are excluded from our hedge targets driven by rising interest rates and favorable prior year equity market performance.
2021 to 2020 Annual Comparison
Revenues increased$11.1 billion from a loss of$2.2 billion for the year endedDecember 31, 2020 to a gain of$8.9 billion for the year endedDecember 31, 2021 . Excluding the impact of our annual reviews and update to our assumptions and other refinements, the increase was$11.3 billion primarily driven by: •Significant Realized investment gains (losses), reflecting a favorable impact to the 2021 Variable Annuities Recapture and portions of theU.S. GAAP liability beforeNPR , that are excluded from our hedge target driven by favorable equity market performance and rising interest rates. Benefits and expenses increased$0.9 billion from$1.8 billion for the year endedDecember 31, 2020 to$2.7 billion for the year endedDecember 31, 2021 . Excluding the impact of our annual reviews and update to our assumptions and other refinements, the increase of$1.1 billion primarily was driven by: •Higher Commission expense primarily driven by the unwinding of assumed deferred acquisition costs, partially offset by ceding allowance received as part of the 2021 Variable Annuities Recapture. Income Taxes
For discussion on income tax related items, see "Business - Regulation" and Note
9 to the Financial Statements.
Liquidity and Capital Resources
Overview
Liquidity is a measure of a company's ability to generate cash flows sufficient
to meet the short-term and long-term cash requirements of the Company. Capital
refers to the long-term financial resources available to support the operations
of our business, fund business growth, and provide a cushion to withstand
adverse circumstances. Our ability to generate and maintain sufficient liquidity
and capital depends on the profitability of our business, general economic
conditions, our ability to borrow and our access to capital markets.
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Effective and prudent liquidity and capital management is a priority across the
organization. Management monitors the liquidity of the Company on a daily basis
and projects borrowing and capital needs over a multi-year time horizon. We use
a Risk Appetite Framework ("RAF") to ensure that all risks taken by the Company
aligns with our capacity and willingness to take those risks. The RAF provides a
dynamic assessment of capital and liquidity stress impacts and is intended to
ensure that sufficient resources are available to absorb those impacts. We
believe that our capital and liquidity resources are sufficient to satisfy the
capital and liquidity requirements of the Company.
Our businesses are subject to comprehensive regulation and supervision by
domestic and international regulators. These regulations currently include
requirements (many of which are the subject of ongoing rule-making) relating to
capital, leverage, liquidity, stress-testing, overall risk management, credit
exposure reporting and credit concentration. For information on these regulatory
initiatives and their potential impact on us, see Item 1 "Business - Regulation"
and Item 1A "Risk Factors".
Capital
We manage FLIAC to regulatory capital levels and utilize the risk-based capital
("RBC") ratio as a primary measure of capital adequacy. RBC is calculated based
on statutory financial statements and risk formulas consistent with the
practices of the National Association of Insurance Commissioners ("NAIC"). RBC
considers, among other things, risks related to the type and quality of the
invested assets, insurance-related risks associated with an insurer's products
and liabilities, equity market and interest rate risks and general business
risks. RBC determines the minimum amount of capital required of an insurer to
support its operations and underwriting coverage. The ratio of a company's Total
Adjusted Capital ("TAC") to RBC is the corresponding RBC ratio. RBC ratio
calculations are intended to assist insurance regulators in measuring an
insurer's solvency and ability to pay future claims. The reporting of RBC
measures is not intended for the purpose of ranking any insurance company or for
use in connection with any marketing, advertising or promotional activities, but
is available to the public. The Company's capital levels substantially exceed
the minimum level required by applicable insurance regulations. Our regulatory
capital levels may be affected in the future by changes to the applicable
regulations, proposals for which are currently under consideration by both
domestic and international insurance regulators.
The regulatory capital level of the Company can be materially impacted by
interest rate and equity market fluctuations, changes in the values of
derivatives, the level of impairments recorded, and credit quality migration of
the investment portfolio, among other items. In addition, the reinsurance of
business or the recapture of business subject to reinsurance arrangements due to
defaults by, or credit quality migration affecting, the reinsurers or for other
reasons could negatively impact regulatory capital levels. The Company's
regulatory capital level is also affected by statutory accounting rules, which
are subject to change by each applicable insurance regulator.
parent, PAI, for the periods indicated below.
Return of Capital
(in millions)
March 31, 2022 $ 306
December 31, 2021 $ 451
September 30, 2021 $ 3,813
June 30, 2021 $ 188
March 31, 2021 $ 192
December 31, 2020 $ 188
September 30, 2020 $ 192
June 30, 2020 $ 173
March 31, 2020 $ 207
Following the previously discussed change in ownership, the Successor Company
did not return capital, including dividends, to FGH during the nine months ended
December 31, 2022 .
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Liquidity
Our liquidity is managed to ensure stable, reliable and cost-effective sources
of cash flows to meet all of our obligations. Liquidity is provided by a variety
of sources, as described more fully below, including portfolios of liquid
assets. Our investment portfolios are integral to the overall liquidity of the
Company. We use a projection process for cash flows from operations to ensure
sufficient liquidity to meet projected cash outflows, including claims.
Liquidity is measured against internally-developed benchmarks that take into
account the characteristics of both the asset portfolio and the liabilities that
they support. We consider attributes of the various categories of liquid assets
(for example, type of asset and credit quality) in calculating internal
liquidity measures to evaluate our liquidity under various stress scenarios,
including company-specific and market-wide events. We continue to believe that
cash generated by ongoing operations and the liquidity profile of our assets
provide sufficient liquidity under reasonably foreseeable stress scenarios.
The principal sources of the Company's liquidity are premiums and certain
annuity considerations, investment and fee income, investment maturities, sales
of investments and internal borrowings. The principal uses of that liquidity
include benefits, claims, and payments to policyholders and contractholders in
connection with surrenders, withdrawals and net policy loan activity. Other uses
of liquidity include commissions, general and administrative expenses, purchases
of investments, the payment of dividends and returns of capital to the
Predecessor parent company, hedging and reinsurance activity and payments in
connection with financing activities.
In managing liquidity, we consider the risk of policyholder and contractholder
withdrawals of funds earlier than our assumptions when selecting assets to
support these contractual obligations. We also consider the risk of future
collateral requirements under stressed market conditions in respect of the
derivatives we utilize.
Liquid Assets
Liquid assets include cash and cash equivalents, short-term investments, fixed maturity securities, and public equity securities. As ofDecember 31, 2022 and 2021, the Company had liquid assets of approximately$6 billion and$12 billion , respectively. The portion of liquid assets comprised cash and cash equivalents and short-term investments was approximately$1 billion and$3 billion as ofDecember 31, 2022 and 2021, respectively. FLIAC entered into an intercompany liquidity agreement with FGH that allows theSuccessor Company to borrow funds of up to$300 million to meet its short-term liquidity and other capital needs. During the nine months endedDecember 31, 2022 , the Company borrowed against the agreement on two separate transactions, each of which was for$75 million . Both transactions were repaid in full, plus interest. As ofDecember 31, 2022 , there were no outstanding borrowings under the agreement. InFebruary 2023 , the Company borrowed$120 million of funds under the agreement, which was subsequently repaid in full, plus interest inMarch 2023 .
Repurchase Agreements and Securities Lending
In the normal course of business, we may enter into repurchase agreements and securities lending agreements with unaffiliated financial institutions, which are typically large or highly rated, to earn spread income and facilitate trading activity. Under these agreements, the Company transfers securities to the counterparty and receives cash as collateral. The cash received is generally invested in short-term investments or fixed maturity securities. For repurchase agreements, a liability representing the amount that the securities will be repurchased is recorded in "Other liabilities" in our consolidated statement of financial position. For securities lending agreements, a liability representing the return of cash collateral is recorded in "Other liabilities" in our consolidated statement of financial position. As ofDecember 31, 2022 , the liabilities associated with our outstanding repurchase and securities lending agreements were$311 million and$106 million , respectively. 43 -------------------------------------------------------------------------------- Table of Contents Financing Activities
Liquidity Regarding Hedging activities
We enter into a range of exchange-traded, cleared, and other OTC derivatives in order to hedge market sensitive exposures against changes in certain capital market risks. The portion of the risk management strategy comprising the hedging portion requires access to liquidity to meet the Company's payment obligations relating to these derivatives, such as payments for periodic settlements, purchases, maturities and terminations. These liquidity needs can vary materially due to, among other items, changes in interest rates, equity markets, mortality, and policyholder behavior. The hedging portion of the risk management strategy may also result in derivative-related collateral postings to (when we are in a net pay position) or from (when we are in a net receive position) counterparties. The net collateral position depends on changes in interest rates and equity markets related to the amount of the exposures hedged. Depending on market conditions, the collateral posting requirements can result in material liquidity needs when we are in a net pay position.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
Market risk is defined as the risk of loss from changes in interest rates, equity prices, and foreign currency exchange rates resulting from asset/liability mismatches where the change in the value of our liabilities is not offset by the change in value of our assets. See Item 1A, "Risk Factors" for a discussion of how difficult conditions in the financial markets and the economy generally may materially adversely affect our business and results of our operations. Market Risk Management Management of market risk, which we consider to be a combination of both investment risk and market risk exposures, includes the identification and measurement of various forms of risk, the establishment of risk thresholds and the creation of processes intended to maintain risks within these thresholds while optimizing returns on the underlying assets or liabilities.
Our risk management process utilizes a variety of tools and techniques,
including:
•Measurement of price sensitivity to market changes (e.g., interest rates,
equity index prices, foreign exchange);
•Hedge Target definition;
•Asset/liability management, which includes our hedging programs; and
•Stress scenario testing related to our risk appetite framework
Measurement of Price Sensitivity to Market Changes
We measure the price sensitivity to market changes on a daily basis.
Sensitivities of both assets and liabilities are gauged and these measurements
form the basis for actions we take under our asset/liability and hedging
programs. We measure both a target level of price sensitivity, as well as
tolerance levels above and below the target, for each market change.
Hedge Target
The definition of the Hedge Target is critical for market risk management, as it specifies the measure of a liability and its attendant price sensitivities. We use a fair value-based measure of the liability as our hedge target. Consistent with our approach to risk manage the full economics of the business, we have established a hedge target that reflects the net present value of the full set of product cash flows. For most of the products in the business, this generally includes:
•Living benefit rider claims we expect to pay in the future;
•Living benefit rider fees we receive over time;
•M&E fees we receive on the base variable annuity contracts;
•Net revenue sharing income we contractually receive;
•Certain product-related expenses; and
•Guaranteed death benefits/fees
44 -------------------------------------------------------------------------------- Table of Contents Asset/Liability Management We manage assets to liability-based measures. For example, we identify target durations for assets based on Hedge Target characteristics and asset portfolios are managed to within ranges around them. This mitigates potential unanticipated economic losses from interest rate and equity price movements. We utilize a combination of fixed income securities and derivatives to implement asset/liability management. To the extent that we identify a mismatch between asset and liability sensitivities, we enter into derivatives transactions to cover the difference. Derivatives are used to supplement risk mitigation provided by the fixed income securities portfolio. Our derivatives primarily include swaps, futures and options contracts that are exchange-traded or contracted in the OTC market.
Stress Scenario Testing Related to Our Risk Appetite Framework
We have established a risk appetite framework that limits the amount of market risks we can take after consideration of our asset/liability management initiatives. We run stress scenario tests periodically to assess the impact of extreme market movements on our balance sheet. This ensures that we have sufficient capital under stressed market conditions.
Market Risk Related to Interest Rates
We perform liability-driven investing and engage in careful asset/liability
management. Asset/liability mismatches create the risk that changes in liability
values will differ from the changes in the value of the related assets.
Additionally, changes in interest rates may impact other items including, but
not limited to, the following:
•Net investment spread between the amounts that we are required to pay and the
rate of return we are able to earn on investments for certain products supported
by general account investments;
•Asset-based fees earned on assets under management or contractholder account
values;
•Estimated total gross profits;
•Net exposure to the guarantees provided under certain products; and
•Our capital levels.
In order to mitigate the impact that an unfavorable interest rate environment
has on our net interest margins, we employ a proactive asset/liability
management program, which includes strategic asset allocation and derivative
strategies within a disciplined risk management framework. We seek to hedge the
interest rate sensitivity of our liabilities with our fixed income assets and
derivatives. Our asset/liability management program also helps manage duration
gaps and other risks between assets and liabilities through the use of
derivatives. We adjust this dynamic process as customer behavior changes and as
changes in the market environment occur.
We use duration and convexity analyses to measure price sensitivity to interest
rate changes. Duration measures the relative sensitivity of the fair value of a
financial instrument to changes in interest rates. Convexity measures the rate
of change in duration with respect to changes in interest rates. We use
asset/liability management and derivative strategies to manage our interest rate
exposure by matching the relative sensitivity of asset and liability values to
interest rate changes, or controlling "duration mismatch" of assets and
liability duration targets. In certain markets, capital market limitations that
hinder our ability to acquire assets that approximate the duration of some of
our liabilities are considered in setting duration targets. We consider
risk-based capital as well as current market conditions in our asset/liability
management strategies.
The Company also mitigates interest rate risk through a market value adjusted
("MVA") provision on certain of the Company's annuity products' fixed investment
options. This MVA provision limits interest rate risk by subjecting the
contractholder to an MVA when funds are withdrawn or transferred to variable
investment options before the end of the guarantee period. In the event of
rising interest rates, which generally make the fixed maturity securities
underlying the guarantee less valuable, the MVA could be negative. In the event
of declining interest rates, which generally make the fixed maturity securities
underlying the guarantee more valuable, the MVA could be positive. The resulting
increase or decrease in the value of the fixed option, from the calculation of
the MVA, is designed to offset the decrease or increase in the market value of
the securities underlying the guarantee.
We assess the impact of interest rate movements on the value of our Retained
Business financial assets, financial liabilities and derivatives using
hypothetical test scenarios that assume either upward or downward 100 basis
point parallel shifts in the yield curve from prevailing interest rates. The
following tables set forth the net estimated changes in fair value on these
financial instruments from an immediate hypothetical 100 basis point upward and
downward parallel shift at December 31, 2022 . Similarly, for the Predecessor
Company , the estimated impact of an immediate hypothetical 100 basis point
downward parallel
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shift is presented further below as of December 31, 2022 . While the test
scenario is for illustrative purposes only and does not reflect our expectations
regarding future interest rates or the performance of fixed income markets, it
is a near-term, reasonably possible hypothetical change that illustrates the
potential impact of such events. These test scenarios do not measure the changes
in value that could result from non-parallel shifts in the yield curve, which we
would expect to produce different changes in discount rates for different
maturities. As a result, the actual change in fair value from a 100 basis point
change in interest rates could be different from that indicated by these
calculations. The estimated changes in fair values do not include separate
account assets.
Successor Company
As of December 31, 2022
Hypothetical Change in Fair Value
Notional Fair Value 100 bps Decrease 100 bps Increase
(in millions)
Assets
Retained Business
Fixed maturity securities $ 3,899 $ 516 $ (411)
Liabilities
Retained Business
Derivatives
Interest rate swaps $ 12,131 $ 325 $ (432) $ 363
Insurance Liabilities
Variable annuities $ 2,665 $ 948 $ (754)
$ 516 $ (391)
Net change $ - $ (20)
Predecessor Company
As of December 31, 2021
Hypothetical
Change in
Notional Fair Value Fair Value
(in millions)
Financial assets with interest rate risk:
Fixed maturities(1) $ 8,798 $ (612)
Policy loans 12 -
Commercial mortgage and other loans 1,516 (75)
Derivatives:
Swaps $ 17,914 $ 175 $ (870)
Futures 910 - -
Options 20,582 (65) 150
Forwards 50 - -
Variable annuity and other living benefit feature embedded
derivatives (4,060) 1,348
Indexed annuity contracts (2,041) (312)
Total embedded derivatives(2) (6,101) 1,036
Financial liabilities with interest rate risk(3):
Policyholders' account balances-investment contracts (2,391) 4
Net estimated potential gain (loss) $ (367)
(1) Includes assets classified as "Fixed maturities, available-for-sale, at fair
value" and "Fixed maturities, trading, at fair value".
(2) Excludes any offsetting impact of derivative instruments purchased to hedge
changes in the embedded derivatives. Amounts reported gross of reinsurance.
(3) Excludes $14 billion as of December 31, 2021 of insurance reserve and
deposit liabilities which are not considered financial liabilities. We believe
that the interest rate sensitivities of these insurance liabilities would serve
as an offset to the net interest rate risk of the financial assets and financial
liabilities, including investment contracts.
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Market Risk Related to Equity Prices
We have exposure to equity risk primarily through asset/liability mismatches,
including our equity-based derivatives, and variable annuity contracts. We
manage equity risk against benchmarks in respective markets. We benchmark our
return on equity holdings against a blend of market indices, mainly the S&P 500
and Russell 2000 for U.S. equities. We benchmark foreign equities against the
MSCI EAFE, a market index of European, Australian and Far Eastern equities. We
target price sensitivities that approximate those of the benchmark indices. For
equity investments within the separate accounts, the investment risk is borne by
the separate account contractholder rather than by the Company.
We estimate our equity risk from an immediate hypothetical 10% change in equity
benchmark levels. The following table sets forth the net estimated potential
change in fair value from such a change in certain of our Retained Business
financial assets, financial liabilities, and derivatives as of December 31,
2022 . Similarly, for the Predecessor Company , the estimated impact of an
immediate hypothetical 10% decrease in equity benchmark levels is presented
further below as of December 31, 2021 . While these scenarios are for
illustrative purposes only and do not reflect our expectations regarding future
performance of equity markets or of our equity portfolio, they do represent
near-term, reasonably possible hypothetical changes that illustrate the
potential impact of such events. In addition, these scenarios do not reflect the
impact of basis risk, such as potential differences in the performance of the
investment funds underlying the variable annuity products relative to the market
indices we use as a basis for developing our hedging strategy. The impact of
basis risk could result in larger differences between the change in fair value
of the equity-based derivatives and the liability in comparison to these
scenarios. In calculating these amounts, we exclude separate account equity
securities.
Successor Company
December 31, 2022
Hypothetical Change in Fair Value
10 percent
Notional Fair Value 10 percent decrease increase
(in millions)
Assets
Retained Business
Derivatives
Equity futures $ 1,737 $ 46 $ (174) $ 174
Equity options 3,286 118 (104) 69
Total Derivatives $ 164 $ (278) $ 243
Liabilities
Retained Business Derivatives Total return swaps $ - $ 25 $ (104) $ 104 Insurance Liabilities Variable annuities 2,665 367 (336) Total$ 2,690 $ 263 $ (232) Net change $ (15) $ 11 47
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Predecessor Company
As of December 31, 2021
Hypothetical
Fair Change in
Notional Value Fair Value
(in millions)
Equity securities $ 322 $ (32)
Equity-based derivatives(2) $ 26,240 (58) (192)
Variable annuity and other living benefit feature
embedded derivatives (4,060) (432)
Indexed annuity contracts (2,041) 628
Total embedded derivatives(3) (6,101) 196
Net estimated potential loss $ (28)
(1)Both the notional amount and fair value of equity-based derivatives and the
fair value of embedded derivatives are also reflected in amounts under "Market
Risk Related to Interest Rates" above and are not cumulative.
(2)Excludes any offsetting impact of derivative instruments purchased to hedge
changes in the embedded derivatives. Amounts reported gross of reinsurance.
Derivatives
We use derivative financial instruments primarily to reduce market risk from changes in interest rates and equity prices, including their use to alter interest rate exposures arising from mismatches between assets and liabilities. Our derivatives primarily include swaps, futures, options and forward contracts that are exchange-traded or contracted in the OTC market. See Notes 5 and 16 to the Financial Statements for more information.
Market Risk Related to Certain Variable Annuity Products
The primary risk exposures of our variable annuity contracts relate to actual
deviations from, or changes to, the assumptions used in the original pricing of
these products, including capital market assumptions, such as equity market
returns, interest rates and market volatility, and actuarial assumptions.
48
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