Unum 2009 Annual Report Download - page 117

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115
Unum 2009 Annual Report
• Forward treasury locks are used to minimize interest rate risk associated with the anticipated purchase or disposal of fixed maturity
securities. A forward treasury lock is a derivative contract without an initial investment where we and the counterparty agree to
purchase or sell a specific U.S. Treasury bond at a future date at a pre-determined price.
• Foreign currency forward contracts are used to minimize foreign currency risks. A foreign currency forward is a derivative without
an initial investment where we and the counterparty agree to exchange a specific amount of currencies, at a specific exchange rate,
on a specific date. We use these forward contracts to hedge the foreign currency risk associated with certain of the debt repayments
of the U.S. dollar-denominated debt issued by one of our U.K. subsidiaries and to hedge the currency risk of certain foreign currency-
denominated long-term bonds owned for diversification purposes.
Our fair value hedging program is as follows:
• Interest rate swaps are used to effectively convert certain of our fixed rate securities into floating rate securities which are used
to fund our floating rate long-term debt. Under these swap agreements, we receive a variable rate of interest and pay a fixed rate
of interest.
Derivative Risks
The basic types of risks associated with derivatives are market risk (that the value of the derivative will be adversely impacted by
changes in the market, primarily the change in interest and exchange rates) and credit risk (that the counterparty will not perform
according to the terms of the contract). The market risk of the derivatives should generally offset the market risk associated with the
hedged financial instrument or liability.
To help limit the credit exposure of the derivatives, we enter into master netting agreements with our counterparties whereby
contracts in a gain position can be offset against contracts in a loss position. We also typically enter into bilateral, cross-collateralization
agreements with our counterparties to help limit the credit exposure of the derivatives. These agreements require the counterparty in a
loss position to submit acceptable collateral with the other counterparty in the event the net loss position meets or exceeds an agreed
upon amount. Our current credit exposure on derivatives, which is limited to the value of those contracts in a net gain position less
collateral held, was $7.0 million at December 31, 2009. We held cash collateral of $24.9 million and $174.3 million from our counterparties
as of December 31, 2009 and 2008, respectively. This unrestricted cash collateral is included in short-term investments and the associated
obligation to return the collateral to our counterparties is included in other liabilities in our consolidated balance sheets. We post fixed
maturity securities as collateral to our counterparties rather than cash. The carrying value of fixed maturity securities posted as collateral
to our counterparties was $123.1 million at December 31, 2009.
The majority of our derivative instruments contain provisions that require us to maintain specified issuer credit ratings and financial
strength ratings. Should our ratings fall below these specified levels, we would be in violation of the provisions, and our derivatives
counterparties could terminate our contracts and request immediate payment. The aggregate fair value of all derivative instruments with
credit risk-related contingent features that are in a liability position as of December 31, 2009 is $144.6 million.
During 2008, we terminated certain of our outstanding derivatives when the credit ratings of the counterparty fell below our
internal investment policy guidelines. At the time of termination, the contracts were in a loss position of $39.1 million. Consistent with our
collateralization agreement, we had previously posted securities as collateral. During 2009, after further discussion with the counterparty it
was determined that we would not receive the value of our collateral or pay the termination amount due to the counterparty. As a result,
we were relieved of our previous liability and recorded a net realized investment loss of $2.3 million on the disposal of the securities posted
as collateral.