MetLife 2003 Annual Report Download - page 56

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METLIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Derivatives Use Plans approved by the applicable state insurance departments. The Company’s derivative hedging strategy employs a variety of
instruments, including financial futures, financial forwards, interest rate, credit default and foreign currency swaps, foreign currency forwards, and options,
including caps and floors.
On the date the Company enters into a derivative contract, management designates the derivative as a hedge of the identified exposure (fair value,
cash flow or foreign currency). If a derivative does not qualify for hedge accounting, according to Statement of Financial Accounting Standards (‘‘SFAS’’)
No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (‘‘SFAS 133’’), the changes in its fair value and all scheduled periodic
settlement receipts and payments are reported in net investment gains or losses.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and
strategy for undertaking various hedge transactions. In this documentation, the Company specifically identifies the asset, liability, firm commitment, foreign
operation, or forecasted transaction that has been designated as a hedged item, states how the hedging instrument is expected to hedge the risks
related to the hedged item, and sets forth the method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness
and the method that will be used to measure hedge ineffectiveness. The Company generally determines hedge effectiveness based on total changes in
fair value of a derivative instrument. The Company discontinues hedge accounting prospectively when: (i) it is determined that the derivative is no longer
effective in offsetting changes in the fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated, or exercised; (iii) the
derivative is de-designated as a hedge instrument; (iv) it is probable that the forecasted transaction will not occur; (v) a hedged firm commitment no longer
meets the definition of a firm commitment; or (vi) management determines that designation of the derivative as a hedge instrument is no longer
appropriate.
The Company designates and accounts for the following as cash flow hedges, when they have met the effectiveness requirements of SFAS 133:
(i) various types of interest rate swaps to convert floating rate investments to fixed rate investments; (ii) various types of interest rate swaps to convert
floating rate liabilities into fixed rate liabilities; (iii) receive U.S. dollar fixed on foreign currency swaps to hedge the foreign currency cash flow exposure of
foreign currency denominated investments; (iv) foreign currency forwards to hedge the exposure of future payments or receipts in foreign currencies; and
(v) other instruments to hedge the cash flows of various other forecasted transactions. For all qualifying and highly effective cash flow hedges, the
effective portion of changes in fair value of the derivative instrument is reported in other comprehensive income or loss. The ineffective portion of changes
in fair value of the derivative instrument is reported in net investment gains or losses. Hedged forecasted transactions, other than the receipt or payment
of variable interest payments, are not expected to occur more than 12 months after hedge inception.
The Company designates and accounts for the following as fair value hedges when they have met the effectiveness requirements of SFAS 133:
(i) various types of interest rate swaps to convert fixed rate investments to floating rate investments; (ii) receive U.S. dollar floating on foreign currency
swaps to hedge the foreign currency fair value exposure of foreign currency denominated investments; (iii) pay U.S. dollar floating on foreign currency
swaps to hedge the foreign currency fair value exposure of foreign currency denominated liabilities, and (iv) other instruments to hedge various other fair
value exposures of investments. For all qualifying and highly effective fair value hedges, the changes in fair value of the derivative instrument are reported
as net investment gains or losses. In addition, changes in fair value attributable to the hedged portion of the underlying instrument are reported in net
investment gains and losses. In addition, changes in fair value attributable to the hedged portion of the underlying instrument are reported in net
investment gains and losses.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative
continues to be carried on the consolidated balance sheet at its fair value, but the hedged asset or liability will no longer be adjusted for changes in fair
value. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the derivative continues to
be carried on the consolidated balance sheet at its fair value, and any asset or liability that was recorded pursuant to recognition of the firm commitment is
removed from the consolidated balance sheet and recognized as a net investment gain or loss in the current period. When hedge accounting is
discontinued because it is probable that a forecasted transaction will not occur, the derivative continues to be carried on the consolidated balance sheet
at its fair value, and gains and losses that were accumulated in other comprehensive income or loss are recognized immediately in net investment gains
or losses. When the hedged forecasted transaction is no longer probable, but is reasonably possible, the accumulated gain or loss remains in other
comprehensive income or loss and is recognized when the transaction affects net income or loss; however, prospective hedge accounting for the
transaction is terminated. In all other situations in which hedge accounting is discontinued, the derivative is carried at its fair value on the consolidated
balance sheet, with changes in its fair value recognized in the current period as net investment gains or losses.
The Company uses forward exchange contracts that provide an economic hedge on portions of its net investments in foreign operations against
adverse movements in foreign currency exchange rates. Unrealized losses on instruments so designated are recorded as components of accumulated
other comprehensive income.
The Company may enter into contracts that are not themselves derivative instruments but contain embedded derivatives. For each contract, the
Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to those of the host contract and
determines whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument.
If it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic
characteristics of the host contract, and that a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative
is separated from the host contract and accounted for as a stand-alone derivative. Such embedded derivatives are recorded on the consolidated
balance sheet at fair value and changes in their fair value are recognized in the current period in net investment gains or losses. If the Company is unable
to properly identify and measure an embedded derivative for separation from its host contract, the entire contract is carried on the consolidated balance
sheet at fair value, with changes in fair value recognized in the current period as net investment gains or losses.
The Company also uses derivatives to synthetically create investments that are either more expensive to acquire or otherwise unavailable in the cash
markets. These securities, called replication synthetic asset transactions (‘‘RSATs’’), are a combination of a credit default swap and a U.S. Treasury or
Agency security, synthetically creating a third replicated security. These derivatives are not designated as hedges. As of December 31, 2003 and 2002,
24 and 16, respectively, of such RSATs, with notional amounts totaling $489 million and $240 million, respectively, were outstanding. The Company
records both the premiums received on the credit default swaps over the life of the contracts and changes in their fair value in net investment gains and
losses.
MetLife, Inc. F-11