8/18/16

1

ColinDevine,CFA,CMA,CFP®colin.devine@cdevineassociates.com

Aug.18,2016

Federal Advisory Committee on Insurance Impact of Low Interest Rates on Life Insurers

CONFIDENTIAL

Agenda

2

StateoftheU.S.LifeInsuranceIndustry 3

InterestRatesandInvestments 8

ImplicaJonsofLowInterestRates 12

OtherEffectsonLifeInsurers 23

WrappingUp 26

8/18/16

2

CONFIDENTIAL

©UFS

StateoftheIndustry

CONFIDENTIAL

LowRatesUniversalChallenge

4

Life Insurers, Individuals, Defined Benefit Pension Plans all in the same boat

Impact of low rate policy means cost to fund future income/benefit payments far higher than planned. •  Risinglongevity,demiseofdefinedbenefitpensionplans,uncertaintyofolderagehealthcostsandlowinterestratescouldmaketheriskofrunningoutofassetsinreJrementbecomeanearcertaintyformany.

•  Whilelowrateshavehelpedhousingpricesandequitymarkets,thepriceofbuying“income”hasrisenover20%duringthelastdecadeasinterestrateshavedeclined.Benefitofnear-termfiscalpolicyiscomingatthecostoflong-termsavers/reJrees.

8/18/16

3

CONFIDENTIAL

Mortality:GoodNews/BadNewsLonger lives means more expensive retirements. Even a 3% inflation rate requires a

doubling of income every 23 years.

Source: Milliman, based on the Annuity 2000 Basic mortality table.

MALE(age65)

FEMALE(age65)

COUPLE(bothage65)

50%chanceof

livingbeyond

50%chanceof

livingbeyond

50%chanceof

livingbeyond

25%chanceof

livingbeyond

25%chanceof

livingbeyond

25%chanceof

livingbeyond

Atleastonepersonhasa…

84 91

87 93

91

96

CONFIDENTIAL

HowAreLifeInsurersDoing?

6

Capitallevelshigh,liquiditysolid,leveragemoderate,financialflexibilitygood…butprofitabilitystagnant.

•  Strainfromlowinterestratessteadilybuildingandplacingincreasingpressureonreserves,productpricing,policydividends,benefitsandprofits.ItwilltakeyearsofFedJghteningtorestoreformerearningsmomentum.

•  Investmentpor_oliosconJnuetobeofhighqualitybutlegacypolicyliabiliJesmaybewherethebiggerriskslieandtheimpactoflowratesfeltthemost.

•  Unlikebanks,lifeinsurersweatheredthefinancialcrisisverywell.OnlytwotookTARPanditwasitsnon-insuranceoperaJonsthatledtotheGovt.takeoverofanother.

Industry health in reasonable shape

8/18/16

4

CONFIDENTIAL

IndustryStatutoryCapitalizaJon

7

RBC not always the whole story

Source: Estimated combined group RBC ratios based on Insurer Year-end 2015 statutory financial reports.

500% 549%

632% 648%

310% 317%

369% 394% 397%

430% 449%

486% 487% 487% 490% 491%

505% 619%

930%

0% 100% 200% 300% 400% 500% 600% 700% 800% 900% 1000%

Mutual D

Mutual C

Mutal B Mutual

A

O N M L K J I

H G F E D C B A

2015 Statutory RBC Ratio

CONFIDENTIAL

©UFS

InterestRatesandInvestments

8/18/16

5

CONFIDENTIAL

LifeInsurersandLowRates

9

Currentrateswellbelowlevelsassumedinpricing

•  BetweenAug.2007-Aug.2016theyieldon10-yearU.S.Govt.bondsfell320bpsto1.5%.Por_olioyieldssJlllosing15-25bpsannuallyandhavenotbeenhelpedbyJghtcreditspreads.

•  MostproblemaJcforlongduraJonliabiliJessuchastradiJonalwholeanduniversallife,long-termcare,fixedandvariableannuiJesbutachallengeforallproducts.

•  Strainonlifeinsurerswouldeaseif10-yearyieldweretogetbackabove4%,butratesrisingtoofastcouldcausedisintermediaJon;50-75bpsannuallywouldbeideal.

Long-term interest rates are the industry’s most important earnings driver

CONFIDENTIAL

LowforLongInterestRates–NewNormal?End of a 30-year fixed income bull market? – What if it’s not?

YE11 YE12 YE13 YE14 YE15 08/12/1610Yr.UST 1.89% 1.78% 3.04% 2.05% 2.27% 1.51%

0

1

2

3

4

5

6

5/16/06 5/16/07 5/16/08 5/16/09 5/16/10 5/16/11 5/16/12 5/16/13 5/16/14 5/16/15 5/16/16

10-YearU.S.TreasuryYields

10

Source: WSJ

8/18/16

6

CONFIDENTIAL

InvestmentQualityaStrength

11

Portfolios in best shape in decades

Investment Grade Corp.

Bonds 62.5%

High Yield 5.1%

ABS/MBS 13.2%

Mortgages 11.6%

Policy Loans 3.2%

Real Estate 0.3% Other

4.1%

Selected U.S. Life Insurer Average YE15 Investment Mix

Source: Annual Company Reports

CONFIDENTIAL

©UFS

ImplicaJonsofLowInterestRatesforU.S.LifeInsurers

8/18/16

7

CONFIDENTIAL

InterestRatesandLiabiliJes

13

•  Long-duraJonliabiliJesrequireassumpJonsforfutureinvestmentratesaswellaspolicyholderbehavior;bothcanbeinfluencedbyavarietyoffactors.Unlikebanks,insurersmakepricingguaranteestheymayhavetolivewithfordecades.

•  RisksofminimumcrediJngrateguaranteesonfixedannuiJesandlifeinsurancepoliciesorassumingfutureinvestmentreturnsonpremiumsareself-evident.

•  Butvariableannuity,universallifeandlong-termcarewritershaveeachlearnedahardlessonaboutlapsesandhowactuarialexperiencecanbeadverselyimpactedbyinterestrates.

Low long-term rates have exacerbated underwriting mistakes made by insurers

CONFIDENTIAL

AllAboutUnderwriJng

14

Investmentsmaybesoldbutmis-pricedliabiliZescanlastalifeZme

•  Maytakedecadesforpoliciestofullyseasonandpricingmistakestoemerge.

•  LegacyliabiliJescanJeupcapital,depressreturnsandtakeyearsorevendecadestofix.TheyalsofacegrowingakenJonfromregulators,raJngagenciesandinvestors.

•  AdjusJngcrediJngrates,de-riskingandre-pricingcaneachhelpimprovereturns,butrarelycantheyfullyputthe“geniebackinthebokle.”

Pricing actuaries can cost an insurer far more than a Chief Investment Officer

8/18/16

8

CONFIDENTIAL

LowforLong

15

PricingassumpZonsareinterdependentandadverseexperienceononeassumpZoncanimpactactuarialexperienceforothers

•  Individuallifeinsurance,annuiJes,pensionclose-outsandsupplementalhealthproductssuchaslong-termcareanddisabilityincomecanbeonaninsurer’sbooksfor20yearsormore.BackinAug.2006,the10-yearyieldwas5.0%.

•  Withthesteadydeclineinlong-termratesandresulJnglowerlevelsofguaranteesonnewproducts,theintrinsicvalueofin-forcepolicieshasrisen.Theyarenotlapsingandwillrequireinsurersbuildhigherlevelsofreservestopayfutureclaims.

Interest rates not only impact spreads but also policyholder behavior and benefits

CONFIDENTIAL

ImplicaJonsofAdverseLapseExperienceInterest rates can impact policyholder behavior

Year5 Year10 Year15 Year205.0%lapserate 77.4% 59.9% 46.3% 35.8%7.5%lapserate 67.7% 45.9% 31.1% 21.0%10.0%lapserate 59.0% 34.9% 20.6% 12.2% 16

0.0

20.0

40.0

60.0

80.0

100.0

120.0

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

IniZalPolicyCo

unt

YearssinceunderwriZng

5.0%lapserate

7.5%lapserate

10.0%lapserate

Changes in lapses can cause material changes to future benefit payments, reserves, and capital requirements

8/18/16

9

CONFIDENTIAL

LowInterestRatesandJapan

17

RegulatoryintervenZonplayedanimportantrole.

•  CombinaJonofverylowlong-terminterestrates,limitedcorporatebondmarket,highminimumcrediJngrateguaranteesandpoorqualityinvestmentsledtoseveralinsolvencies.

•  However,manycompaniesalsobenefitedfromextremelyfavorablemortalitygainsduetotheindustry’suseofhighlyconservaJvehistoricmortalitytables.

•  WhileinterestspreadsformostJapaneselifeinsurersaresJllnegaJve,itisslowlyimprovingandconJnuestobeoffsetbymortalityexperiencethatremainsveryposiJve.

Japanese life insurers have managed through decades of low interest rates

CONFIDENTIAL

Legacyliabilityexamples

18

•  Individualdisability–Non-cancellableownoccupaJonpoliciesthatoneinsurerwroteupunJltheearly90’ssJllrepresentaboutone-thirdofitsgeneralaccountreserves.Noabilitytoraisepremiumstooffsetdropininterestrates.Approx.95%areonclaimandblocklapsingataround5%.

•  VariableannuiZes-InsurersquicktoprovidegenerouslivingbenefitsbutslowtorecognizeincreasedrisksastheybecameSPIAsin“disguise.”BenefituJlizaJontrackingover80%withlapsesof5%-8%vs.10%-plusassumedinpricing.Equitymarketrecoveryhashelpedreduce“inthemoneyness”ofguarantees.

Low interest rates have exacerbated underwriting mistakes made by insurers

8/18/16

10

CONFIDENTIAL

WhatchangedforVariableAnnuiJesIRAs became dominant source of funds for living benefits

19

41%

51% 53%

58% 60% 59%

49% 47%

42% 40%

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 11 '12 13

Percent of Deferred VA Retail Sales

IRA Nonqualified

Source: U.S. Individual Annuities survey, LIMRA SRI . Retail = IRA + Nonqualified annuity sales.

CONFIDENTIAL

LiabiliJescont’d.

20

•  Universallife–InsurershavebeenimplemenJngsignificantincreasesforcostofinsurance(COI)tooffsetfarlowerinvestmentreturnsthanassumedinpricing.Causingmuchfastercashvalueerosionandhasspurredahostoflawsuits.PolicieswithsecondaryguaranteeshavelifeJmepricingeffecJvely“lockedin”withlimitedabilitytochangeCOIandarealsofacinghighercapitalrequirements.

•  Long-termcare–Pricingoverlyreliantonlapsesupport.Tocompensateforuninsurableolderagehealthriskandlowerthanassumedinvestmentreturnsonrenewalpremiums,carriershaveexitedthemarketwhileothersareseekingrateincreasesof20%,30%,40%ormore.

“Measure twice cut once”

8/18/16

11

CONFIDENTIAL

LowRatesMeanHigherFutureReserves

Liability reserves build up over many years. For Products such as SGUL, LTC, and VA Insurers may face much higher reserve levels to generate sufficient returns to pay claims payments

21

Source: Ernst & Young.

In response too low rates the GAAP reserve may grow to the size of the SAAP reserve or more.

CONFIDENTIAL

AdapJngtoLowforLongRates

22

Carriershaveraisedpremiumrates,reducedbenefitsandexitedproductlinessuchasVAsandLTCduetoadverseexperience.

•  AnJcipategrowingshirtocombinaJonorlinked-benefitproductsthatprovidemoreflexibilityforfuturere-pricingaswellasupside“parJcipaJng”potenJalforpolicyholderifexperienceisfavorable.

•  Lookforgreaterfocusonhighpersistencyproductspricedfor“zero”rateenvironmentthatcantransiJonthroughlifestageswithoutlapsesupportedpricing.

•  IncreaseduseofriderssopolicyholderscancustomizeproductstotheirneedsandallowinsurerstomoreeffecJvelypricerisk.

Life industry adapting and re-inventing

8/18/16

12

CONFIDENTIAL

©UFS

OthereffectsonLifeInsurersofLowInterestRates

CONFIDENTIAL

ShareValuaJonsHaveLagged

24

FinancialsaresZllonlysectorofS&P500thathavenotreturnedtopre-crisissharevaluaZonlevels.

•  Between2006-16lifesharesoffapprox.3%vs.44%gainforS&P500.YTDS&PLifeindexdown1.3%vs.6.9%gainforS&P500.

•  LifeinsurervaluaJonsmaybelookingthroughaccounJngandinlinewithhistoriclevelsondiscountedfairvalue“economic”basis.

Anticipate life stocks will largely trade in line with direction of interest rates

Price / Book Ratio 2006 2008 2015 08/12/16 S&P 500 2.9x 2.0x 2.8x 2.9x Life/Health Insurers 1.7x 1.4x 0.9x 1.1x

P/E Ratio S&P 500 17x 16x 18x 16x Life/Health Insurers 14x 10x 11x 10x

8/18/16

13

CONFIDENTIAL

M&AWarmingup-Somewhat

25

Notablerecentdealsinclude:

ProtecJveLife–Dia-ichi$5.7B

StanCorp–MeijiYasuda$5.0BSymetra–Sumitomo$3.8B

•  LookforM&AtostaymoderatewithafocusonopportunisJcdisposiJons.WillconJnuetobeareluctancetotakeonproblemsofothers–manyhaveenoughoftheirown

•  Regulatoryissuesmaycausesomeinsurerstore-thinktheirpresenceintheU.S.Couldtaketheformofout-rightspin-offs,divesJturesorbusinesslinesales.

Resurgence led by Japanese buyers

CONFIDENTIAL

©UFS

WrappingUp

8/18/16

14

CONFIDENTIAL

CauJouslyOpJmisJcOutlook

27

LowinterestratesposeaformidableriskbutconfidentindustryisalreadyadjusZngbusinessmodelstoanewparadigm.

•  Lifeinsurancesectorpossessesgoodlong-termgrowthpotenJalJedtofavorabledemographictrendsandashirinfocustowardsprotecJonagainstrisinglongevityvs.prematuremortality.

•  Industry’sabilitytoconJnueprovidingproductstohelpreJreesmanagefinancialsecurityisatriskandwillbeJedtodirecJonofinterestrates,regulatorycapitalreformsandconsumerprotecJon.

•  RestoringearningsmomentumwillbeslowbutdonotanJcipateafuture“solvency”crisisforlifeinsurers.EffecJvenessofexisJngregulatorysupervisionwasvekedduringthefinancialcrisis.

Life Insurance is a marathon not a sprint

CONFIDENTIAL

WhyLifeInsurersMaker

28

Threeclosingthoughts:

“Americansshouldconvertatleasthalfoftheirre4rementsavingsintoanannuity”USTreasuryDept.

“Thereisalackoffinancialeduca4onaboutthebenefitsofannui4esandwhat’savailable”USGovernmentAccountabilityOffice

BenBernanke,formerU.S.FederalReserveChairman,ownstwoannui4eswhichrepresentthelargestpercentageofhisownpersonalinvestmentholdings…......sodoI.

Only life insurers can guarantee lifetime income and offer tax-free death benefits

8/18/16

15

CONFIDENTIAL

Thank You

29

CONFIDENTIAL

ColinDevineprovidesstrategicadvisoryservicestotheinsuranceandinvestmentmanagementsectorsonahostofindustryissuesincludingcapitalandriskmanagement,generalaccountinvestments,variableannuityde-risking,reJrementincomeproductsandinvestorrelaJons.Heisalsoafrequentguestspeakeratvariousindustryconferencesaswellascorporateboardsofdirectors.

Previously,ColinwasaManagingDirectorwithbothJefferiesLLCandCiJgroupresponsibleforequityresearchcoverageofNorthAmericanlifeinsurancecompanies.HewasontheInsJtuJonalInvestorAll-AmericaResearchTeamfor14straightyearswhereheheldthe#1rankingintheLifeInsuranceEquityResearchcategoryforsixconsecuJveyears.Colinwasalsonamedoneofthe“LastHonestAnalysts”bySmartMoneyMagazine.

BeforejoiningCiJgroup,ColinwasaDirectorinStandard&Poor'sInsuranceRaJngsgroup.Precedingthat,ColinwasavicepresidentofamajorCanadianlifeinsurerwherehewasinvolvedininvestmentandriskmanagementaswellasanumberofcorporatedevelopmentandtreasuryiniJaJves.

30

ColinW.DevineCFA,CMA,CFP®