know about this FORTITUDE LIFE INSURANCE & ANNUITY CO – 10-Q – Management discussion and analysis of financial condition and results of operations
in complete details.
April 1, 2022, Fortitude Life Insurance & Annuity Company("FLIAC" or the "Company"), which was previously named Prudential Annuities Life Assurance Corporation("PALAC"), was a wholly-owned subsidiary of Prudential Annuities, Inc("PAI"), an indirect wholly-owned subsidiary of Prudential Financial, Inc. ("Prudential Financial"), a New Jersey Corporation. On April 1, 2022PAI completed the sale of its equity interest in the Company to Fortitude Group Holdings, LLC("FGH"). As a result, the Company is no longer an affiliate of Prudential Financial or any of its affiliates. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the financial condition of FLIAC as of June 30, 2022and its results of operations for the three months ended June 30, 2022. The MD&A also addresses the results of operations of PALAC for the three months ended March 31, 2022compared to the same prior year period. Other periods presented on the statement of financial condition or statement of operations are not comparable due to the election to apply "pushdown" accounting to the Company following its acquisition by FGH. See Accounting Pronouncements and Policies for further information. You should read the following analysis of our financial condition and results of operations in conjunction with the MD&A, the "Risk Factors" section, and the audited Financial Statements included in the Predecessor Company'sAnnual Report on Form 10-K for the year ended December 31, 2021, as well as the statements under "Forward-Looking Statements", and the Unaudited Interim Financial Statements included elsewhere in this Quarterly Report on Form 10-Q. 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 annuities with (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"), and (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 ceased offering these products.
Reinsurance transactions of the predecessor company
April 1, 2016, the Company reinsured the variable annuity base contracts, along with the living benefit guarantees, from Pruco Life Insurance Company("Pruco Life"), excluding the Pruco Life Insurance Company of New Jersey("PLNJ") business which was reinsured to The Prudential Insurance Company of America(" Prudential Insurance"), in each case under a coinsurance and modified coinsurance agreement. This reinsurance agreement covers new and in force business and excludes business reinsured externally. As of December 31, 2020, Pruco Life discontinued the sales of traditional variable annuities with guaranteed living benefit riders. The discontinuation has no impact on the reinsurance agreement between Pruco Life and the Company. Effective July 1, 2021, Pruco Life recaptured the risks related to its business, as discussed above, that had previously been reinsured to the Company from April 1, 2016through June 30, 2021. The product risks related to the previously reinsured business that were being managed in the Company, were transferred to Pruco Life. In addition, the living benefit hedging program related to the previously reinsured living benefit riders will be managed within Pruco Life after the recapture. This transaction is referred to as the "2021 Variable Annuities Recapture". See Note 1 to the Financial Statements included in the Predecessor Company'sAnnual Report on Form 10-K for the year ended December 31, 2021, for more details. Effective December 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. 61 -------------------------------------------------------------------------------- Table of Contents 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 the current period and is expected to impact our results of operations in future periods. The Company has taken several measures to manage the impacts of this crisis.
•Operating Results. See “Results of Operations” for a discussion of the results.
for the second quarter of 2022.
•Risk Factors. The COVID-19 pandemic has adversely impacted our results of operations, financial position, investment portfolio, new business opportunities and operations, and these impacts are expected to continue. For additional information on the risks to our business posed by the COVID-19 pandemic, see "Risk Factors" included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2021.
Impact of a changing interest rate environment
As a financial services company, market interest rates are a key driver of our 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; •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 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”
included in the
Revenues and Expenses The Company earns revenues principally from contract charges, mortality and expense fees, asset administration fees from annuity and investment products and from net investment income on the investment of general account and other funds. The Company earns contract fees, mortality and expense fees and asset administration fees primarily from the sale and servicing of annuity products. The Company's operating expenses principally consist of annuity benefit guarantees provided and reserves established for anticipated future annuity benefit guarantees and costs of managing risk related to these products, interest credited to contractholders' account balances, general business expenses, reinsurance premiums, commissions and other costs of selling and servicing the various products it sold. Accounting Policies & Pronouncements
Application of Critical Accounting Estimates
The preparation of financial statements in conformity with
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, the Company's results of operations and financial position as reported in the Unaudited Interim Financial Statements could change significantly. 62
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Following the acquisition of FLIAC, we have elected to apply "pushdown" accounting to the Company. The application of "pushdown" accounting creates a new basis of accounting for all assets and liabilities based on fair values. As a result, the Company's financial position and results of operations 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 to March 31, 2022is referred to as the Predecessor Companynamed "PALAC". The post-acquisition period, April 1, 2022and forward, includes the impact of acquisition accounting and is referred to as the Successor Company, named "FLIAC".
Management believes that the accounting policies related to the following areas are
more dependent on the application of estimates and assumptions and require
management’s most difficult, subjective, or complex judgments:
•Insurance liabilities; •Valuation of investments, including derivatives; •Reinsurance recoverables/payables; •Taxes on income; and •Reserves for contingencies, including reserves for losses in connection with unresolved legal matters.
Future 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 the
Financial Accounting Standards Board("FASB") on August 15, 2018. Large calendar-year public companies that early adopt ASU 2018-12 are allowed to apply the guidance either as of January 1, 2020or January 1, 2021(and record transition adjustments as of January 1, 2020or January 1, 2021, respectively) in the 2022 financial statements. Companies that do not early adopt ASU 2018-12 would apply the guidance as of January 1, 2021(and record transition adjustments as of January 1, 2021) in the 2023 financial statements.
As discussed above, the Company has elected to apply the fair value option
for all your insurance obligations. As a result of this choice, the
The company’s insurance liabilities are no longer within the scope of ASU 2018-12.
Table of Contents Segment and Product Overview Our business is comprised of two major blocks of in-force policies, which we refer to as the "Retained Business" and the "Ceded Business". The Retained Business consists of variable annuity products with guaranteed lifetime withdrawal benefit features as well as smaller blocks of variable annuity products with certain other living benefit and death benefit features. The Retained Business also includes variable universal life and fixed payout annuity products. The Retained Business is actively managed by FLIAC management and the
Successor Companyretains the full economic benefits and risks. The Retained Business consists of approximately 230,000 variable annuity contracts originated between 1993 - 2010. These products allow the holder to direct investments into certain separate account funds to receive tax deferred build-up within the contract. Most of the contracts have optional living benefit riders, which entitle the holder to elect to withdraw a guaranteed amount from the contract while he/she is alive, irrespective of the balance in his/her separate account (GMWB). Almost all of the contracts also offer a guaranteed amount payable to a beneficiary upon the death of the holder (GMDB). The Ceded Business represents certain business (primarily registered index linked-annuities and fixed annuities, which includes fixed indexed and fixed deferred annuities, and other variable annuities) where 100 percent of the assets and liabilities have been fully ceded to The Prudential Insurance Company of America(PICA) and Pruco Life Insurance Company(Pruco Life) under existing coinsurance and modified coinsurance agreements. The Ceded Business will continue to impact certain line items within the Company's financial statements but will not have a material impact to stockholders' equity or net income and will be the economic impact of PICA and Pruco Life. In addition, PFI has instituted, in accordance with applicable state law, a program to novate a significant portion of the Ceded Business policies from FLIAC to either PICA or Pruco Life. This program was initiated in May 2022and is not expected to have a material impact on the financial statements but will result in the reduction of certain activity/balances associated with these policies. Changes in Financial Position As noted under Accounting Policies and Pronouncements, the Company's financial position subsequent to the acquisition is not comparable with that prior to April 1, 2022. As a result, the following discussion regarding changes in the financial position of the Company will be based on changes subsequent to the acquisition-date balance sheet as of April 1, 2022. Also included below is discussion regarding the changes from December 31, 2021to March 31, 2022as previously disclosed in the Predecessor Company'sfirst quarter of 2022 10-Q. Successor CompanyRetained Business Assets decreased approximately $3.8 billionfrom $32.1 billionat April 1, 2022to $28.3 billionat June 30, 2022. The decrease was primarily driven by a $4.0 billiondecline in separate account assets due to market depreciation resulting mostly from unfavorable equity market performance. Liabilities decreased approximately $3.8 billionfrom $30.3 billionat April 1, 2022to $26.5 billionat June 30, 2022. The decrease was primarily driven by a decline in separate account liabilities, corresponding to the decrease in separate account assets, as discussed above. Equity was $1.8 billionat both April 1, 2022and June 30, 2022, with a net loss of $180 millionoffset by an increase in our own-credit risk (OCR) impact on the fair value of insurance liabilities of $194 millionreflected in accumulated other comprehensive income (loss).
$2.1 billionfrom $13.2 billionat April 1, 2022to $11.2 billionat June 30, 2022. The decrease was primarily driven by a $1.7 billiondecline in total investments due to the previously mentioned novations during the second quarter of 2022. Also contributing to the decline in total investments were losses related to derivatives and losses in the fixed maturity securities portfolio resulting from rising interest rates. 64
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$2.1 billionfrom $13.2 billionat April 1, 2022to $11.2 billionat June 30, 2022. The decrease was primarily driven by a $2.4 billiondecline in the fair value of insurance liabilities, which was primarily driven by the previously mentioned novation of a portion of the business during the second quarter of 2022.
There was no capital within our Assigned Business in both
Total assets decreased
• $2.8 billion decrease in separate account assets primarily driven by
unfavorable stock market performance and net outflows.
Total liabilities decreased
• $700 million decrease in future policy benefits driven by a decrease in
reserves related to our variable annuity living benefit guarantees due to
widening default risk (“NPR”) spreads and rising interest rates.
• Decrease of $2,800 million in Liabilities of Separate Accounts corresponding to the
decrease in separate account assets, as discussed above.
Total equity decreased
$0.4 billionfrom $1.7 billionat December 31, 2021to $1.3 billionat March 31, 2022, primarily driven by $0.4 billionof 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. Results of Operations As noted under Accounting Policies and Pronouncements, the Company's results of operations subsequent to the acquisition is not comparable with those prior to April 1, 2022. As a result, the following discussion regarding the results of operations of the Successor Companywill not be compared to previous periods and will be based solely on activity for the period subsequent to the acquisition. Also included below is discussion regarding the results of operations as previously disclosed in the Predecessor Company'sfirst quarter of 2022 10-Q.
LOSS FROM OPERATIONS BEFORE INCOME TAXES
three months done
The loss from operations before income taxes of
$231 millionwas driven primarily by changes in the fair value of insurance liabilities from April 1, 2022, excluding changes in OCR, driven primarily by a decline in equity markets, partially offset by higher interest rates. Also contributing to the loss from operations before income taxes were investment losses primarily in the fixed maturity securities portfolio resulting from higher interest rates and 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 policy charges and fee income and net investment income.
There was no impact on operating loss before income tax as a net
investment income and investment losses were fully offset by changes in fair value
value of insurance liabilities and policyholder benefits.
65 -------------------------------------------------------------------------------- Table of Contents REVENUES, BENEFITS, AND EXPENSES Three Months Ended
June 30, 2022Retained Business
primarily from policy charges and commission income, net investment income and
investment losses that resulted from increases in market interest rates during the
period that resulted in a corresponding impact on the fair value of the
securities held to maturity and interest rate swaps.
Benefits and expenses were
$313 millionfor the three months ended June 30, 2022and primarily driven by the increase 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
There was no impact on operating loss before income taxes as all
income and expenses are returned to PICA or Pruco Life.
66 -------------------------------------------------------------------------------- Table of Contents PREDECESSOR COMPANY
LOSS FROM OPERATIONS BEFORE INCOME TAXES
three months done
Income (loss) from operations before income taxes decreased
$2 billionfrom a gain of $2.4 millionfor the three months ended March 31, 2021to a gain of $0.4 billionfor the three months ended March 31, 2022, primarily driven by: •Realized investment gains (losses), net decrease reflecting prior year's favorable impact related to the portions of our U.S.GAAP liability before NPR, that are excluded from our hedge targets driven by rising interest rates and favorable prior year equity market performance.
three months done
Income (loss) from operations before income taxes increased
$2,519 millionfrom a loss of $2,618 millionfor the three months ended June 30, 2020to a loss of $99 millionfor the three months ended June 30, 2021. Excluding the impact of our annual reviews and update of assumptions and other refinements, income (loss) from operations increased $2,437 millionprimarily driven by: •Favorable impact related to the portions of our U.S.GAAP liability before non-performance risk ("NPR"), that are excluded from our hedge target, driven by favorable equity market performance, partially offset by declining interest rates. Also contributing is an unfavorable NPRadjustment. Prior year period reflected an increase in these reserves primarily driven by an unfavorable NPRadjustment and unfavorable hedge breakage driven by tightening of credit spreads, partially offset by the tightening of credit spreads used to measure our living benefit liability.
six months over
Income (loss) from operations before income taxes increased
$5,962 millionfrom a loss of $3,677 millionfor the six months ended June 30, 2020to income of $2,285 millionfor the six months ended June 30, 2021. Excluding the impact of our annual reviews and update of assumptions and other refinements, income (loss) from operations increased $5,879 millionprimarily driven by: •Favorable impact related to the portions of our U.S.GAAP liability before NPR, that are excluded from our hedge target driven by favorable equity market performance and rising interest rates. These increases were partially offset by an unfavorable NPRadjustment. Prior year period reflected an increase in these reserves primarily driven by declining interest rates, widening of credit spreads, and unfavorable hedge breakage, partially offset by a favorable NPRadjustment used to measure our living benefit liability. 67 -------------------------------------------------------------------------------- Table of Contents The following table provides the net impact to the Unaudited Interim Statements of Operations for the Predecessor Company, which is primarily driven by the changes in the U.S.GAAP embedded derivative liability and hedge positions under the Asset Liability Management ("ALM") strategy, and the related amortization of DAC and other costs. Predecessor Company Three Months Three Months Ended Ended Six Months Ended March 31 June 30 June 30 2022 2021
Change in the value of the USGAAP liability, before
$ (1,883)$ 5,581 Change in the NPR adjustment 156 (104) (903) Change in fair value of hedge assets, excluding capital hedges(3) (392) 1,334 (3,112) Change in fair value of capital hedges(4) 39 (503) (803) Other 218 578 1,106
Gains (losses) on realized investments, net and related
480 (578) 1,869 Market experience updates(5) (57) 92 161 Charges related to realized investments gains (losses), net (97) 74 (260)
Net impact due to changes in the
derivatives and hedging positions, after the impact of
$ (412)$ 1,770
INCOME, BENEFITS AND EXPENSES
three months done
$2.4 billionfrom a gain of $3.1 billionfor the three months ended March 31, 2021to a gain of $0.7 billionfor the three months ended March 31, 2022primarily driven by: •Realized investment gains (losses), net decrease reflecting prior year's favorable impact related to the portions of our U.S.GAAP liability before NPR, that are excluded from our hedge targets driven by rising interest rates and favorable prior year equity market performance.
three months done
$2,841 millionfrom a loss of $2,641 millionfor the three months ended June 30, 2020to a gain of $200 millionfor the three months ended June 30, 2021. Excluding the impact of our annual reviews and update of our assumptions and other refinements, revenues increased $2,955 millionprimarily driven by: •Higher Realized investment gains (losses), net reflecting favorable impact related to the portions of our U.S.GAAP liability before NPR, that are excluded from our hedge target driven by favorable equity market performance, partially offset by declining interest rates. Also contributing is an unfavorable NPRadjustment. Benefits and expenses increased $321 millionfrom income of $22 millionfor the three months ended June 30, 2020to an expense of $299 millionfor the three months ended June 30, 2021. Excluding the impact of our annual reviews and update of our assumptions and refinements, benefits and expenses increased $518 millionprimarily driven by: •Higher Amortization of deferred policy acquisition costs driven by changes to expected gross profits reflecting change in market conditions; and •Higher Policyholders' benefits driven by our guaranteed minimum death benefits due to unfavorable market conditions, resulting in higher reserve provisions. 68
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June 30, 2021Revenues increased $5,939 millionfrom a loss of $2,617 millionfor the six months ended June 30, 2020to a gain of $3,322 millionfor the six months ended June 30, 2021. Excluding the impact of our annual reviews and update to our assumptions and other refinements, revenues increased $6,053 millionprimarily driven by: •Higher Realized investment gains (losses), net reflecting favorable impact related to the portions of our U.S.GAAP liability before NPR, that are excluded from our hedge target driven by favorable equity market performance and rising interest rates. These increases were partially offset by an unfavorable NPRadjustment. Benefits and expenses decreased $23 millionfrom $1,060 millionfor the six months ended June 30, 2020to $1,037 millionfor the six months ended June 30, 2021. Excluding the impact of our annual reviews and update to our assumptions and other refinements, benefits and expenses increased $174 millionprimarily driven by:
•Higher Amortization of deferred costs of policy acquisition driven by changes in
expected gross earnings reflecting changes in market conditions.
Retained Business Strategies and Risk Management We manage the Retained Business with a focus on long-term economics and a willingness to sustain short-term volatility in our earnings, while remaining compliant with our risk appetite framework. Our overall business strategy is to generate above-market risk adjusted returns by: •Ensuring we have a strong statutory balance sheet following capital market stresses, including but not limited to, sharp reductions in equity prices and interest rates and increases in credit spreads, •Leveraging our investment capabilities to deploy a portion of our asset portfolio into private fixed income securities with a sufficiently wide spread to comparable public securities, •Investing in high-quality liquid public fixed income securities and preserving a cash balance sufficient to pay current claims and expenses, while maintaining collateral to satisfy margin requirements in connection with the derivative transactions forming our Asset Liability Matching (ALM) strategy, as described below. The primary risk exposures of our Retained Business relate to actual deviations from, or changes to, the pricing assumptions developed at acquisition for these products, including capital markets assumptions such as equity market returns, interest rates and market volatility, along with actuarial assumptions such as contractholder mortality, the timing and amount of annuitization and withdrawals, and contract lapses. For these risk exposures, achievement of our expected returns is subject to the risk that actual experience will differ from the pricing assumptions developed at acquisition for these products. We have developed and implemented a risk management strategy to mitigate the potential adverse effects of fluctuations in capital markets, specifically equity markets and interest rates, primarily through a combination of i) Product Design Features and ii) our ALM strategy.
Product Design Features
A portion of the variable annuity contracts includes an asset transfer feature. This feature is implemented at the contract level, and transfers assets between certain variable investment sub-accounts selected by the annuity contractholder and, depending on the benefit feature, a fixed-rate account in the general account or a bond fund sub-account within the separate account. The objective of the asset transfer feature is to reduce our exposure to equity market risk and market volatility. The transfers are based on a static mathematical formula used with the particular benefit which considers a number of factors, including, but not limited to, the impact of investment performance on the contractholder's total account value. Other product design features we utilize include, among others, asset allocation restrictions, minimum issuance age requirements and certain limitations on the amount of contractholder purchase payments.
We employ an ALM strategy that utilizes a combination of both fixed income instruments and derivatives to meet expected claims associated with our variable annuity living and death benefit guarantees. The economic liability we manage with this ALM strategy consists of expected living and death benefit claims net of expected separate account fee revenue. For the portion of our ALM strategy executed with derivatives, we enter into a range of exchange-traded and over-the-counter ("OTC") equity, interest rate and credit derivatives, including, but not limited to: equity and treasury futures; total return, credit default and interest rate swaps; and options, including equity options, swaptions, and floors and caps. The intent of this strategy is to 69 -------------------------------------------------------------------------------- Table of Contents more efficiently manage the capital and liquidity associated with these products. We explicitly consider liquidity and risk-based capital as well as current market conditions in our asset/liability management strategies. Below is specific discussion on our ALM strategy regarding interest and equity risks:
Market risk related to interest rates
In order to mitigate the impact that an unfavorable interest rate environment has on our net interest margins, we employ strategic asset allocations and derivative strategies within a disciplined risk management framework. These strategies seek to target the interest rate sensitivity of the assets to a certain percentage of the estimated interest rate sensitivity of the product liabilities. Our asset/liability management program is holistic, in that it considers contributions from both our fixed income asset portfolio, as well as our interest rate derivatives, in offsetting the interest rate sensitivity of our liabilities. 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 managing the relative sensitivity of asset and liability values to interest rate changes to within a certain prescribed tolerance range.
Market risk related to share prices
We have exposure to equity risk primarily through the impact of changes in equities prices on the incidence and magnitude of future contractholder claims, as well as fee revenue. We manage this risk using equity-based derivatives. As with interest rate risk, we target the equity sensitivity of the assets (equity derivatives) to a certain percentage of the estimated equity market sensitivity of the economic liability. We manage the relative sensitivity of asset and liabilitiy values to equity price changes to within a certain prescribed tolerance range. We manage equity risk against benchmarks in respective markets. We benchmark returns of equity holdings against a blend of market indices, mainly the S&P 500 and Russell 2000 for
U.S.equities. We benchmark foreign equity returns 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. Income Taxes
For information on income taxes, see Note 8 of the Interim Unaudited Reports.
Liquidity and Capital Resources This section supplements and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources" included in our Annual Report on Form 10-K for the year ended
December 31, 2021.
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. 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, including scenarios similar to, and more severe than, those occurring due to COVID-19, 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. 70 -------------------------------------------------------------------------------- Table of Contents 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 "Business-Regulation" and "Risk Factors" included in the
Predecessor Company'sAnnual Report on Form 10-K for the year ended December 31, 2021.
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.
monthly periods indicated below. Following the change discussed above in
Return of Capital (in millions) March 31, 2022 $ 306 December 31, 2021 $ 451 September 30, 2021 $ 3,813 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 parent company, hedging and reinsurance activity and payments in connection with financing activities. 71 -------------------------------------------------------------------------------- Table of Contents 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 include cash and cash equivalents, short-term investments,
U.S. Treasuryfixed maturities and fixed maturities that are not designated as held-to-maturity, and public equity securities. As of June 30, 2022and December 31, 2021, the Company had liquid assets of $9 billionand $12 billion, respectively. The portion of liquid assets comprised cash and cash equivalents and short-term investments was $1.6 billionand $2.9 billionas of June 30, 2022and December 31, 2021, respectively.
Hedging activities associated with life benefit guarantees and other markets
The hedging portion of our risk management strategy associated with our living benefit guarantees, including those assumed from Pruco Life, is being managed within the Company. For the portion of the risk management strategy executed through hedging, we enter into a range of exchange-traded, cleared and other OTC equity and interest rate derivatives in order to hedge certain living benefit guarantees and other 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. 72
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