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UNUM • 2014 ANNUAL REPORT 121
Derivatives not designated as hedging instruments and used to reduce our exposure to foreign currency risk and credit losses on
securities owned are as follows:
• Foreign currency interest rate swaps previously designated as hedges were used to hedge the currency risk of certain foreign
currency-denominated fixed maturity securities owned for portfolio diversification. We agree to pay, at specified intervals, fixed rate
foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the
operating segment. We hold offsetting swaps wherein we agree to pay fixed rate principal and interest payments in the functional
currency of the operating segment in exchange for fixed rate foreign currency-denominated payments.
• Credit default swaps are used as economic hedges against credit risk but do not qualify for hedge accounting. A credit default swap
is an agreement in which we agree with another party to pay, at specified intervals, a fixed-rate fee in exchange for insurance against
a credit event on a specific investment. If a defined credit event occurs, our counterparty may either pay us a net cash settlement, or
we may surrender the specific investment to them in exchange for cash equal to the full notional amount of the swap. Credit events
typically include events such as bankruptcy, failure to pay, or certain types of debt restructuring.
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, including
accrued interest receivable less collateral held, was $13.6 million at December 31, 2014. We held cash collateral from our counterparties
of $15.4 million and $1.1 million at December 31, 2014 and 2013, respectively. We post either fixed maturity securities or cash as collateral
to our counterparties. The carrying value of fixed maturity securities posted as collateral to our counterparties was $67.0 million and
$95.6 million at December 31, 2014 and 2013, respectively. We had no cash posted as collateral to our counterparties at December 31, 2014
and 2013. See Note 3 for further discussion of our master netting agreements.
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 were in a liability position was $92.9 million and $135.6 million at December 31, 2014
and 2013, respectively.