Variable Annuity Products: Responding to a Low Interest ... · PDF fileVariable Annuity...

Sponsored by

and

Variable Annuity Products: Responding to a Low

Interest Rate Environment

Presenter(s):

Amit Ayer

VARIABLE ANNUITY (“VA”) PRODUCTS: RESPONDING TO A LOW INTEREST RATE ENVIRONMENT

11th Annual Equity Based Insurance Guarantee Conference (Chicago)

Session 3A: November 16, 2015 (1530 – 1700 hours)

Amit Ayer

Agenda

VA landscape

Impacts to / Responses of VA writers to low interest rate environment

– New business

– Product

– Profitability

– Reinsurance markets

– Divestiture strategies

– Alternative products

Questions and answers

2

VA LANDSCAPE

Industry consolidation continues, as ten VA writers accounted for ~80% of sales in 2014

Market share of sales for top 10 VA writers

4

DAC

GAAP

value of

guarantee

fees

SOP 03-01

guarantees

Source: JP Morgan Market Share Bible Vol. LXIV

17.0%

9.6% 9.4% 9.2%

7.4% 7.3%6.8%

4.7% 4.5%

3.3%

JacksonNational Life

LincolnNational

AIGSunAmerica

TIAA-CREF Aegon /Transamerica

PrudentialFinancial

AXAFinancial

MetLife NationwideFinancial

Pacific Life0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

YE

201

4 S

ale

s M

ark

et

Sh

are

Commentary• VA sales are projected to drop 1% in

2015 following a 4% decline in 2014

• Lincoln’s market share is driven by

sales of ChoicePlus Assurance

• Jackson National continues to

dominate VA sales

– Perspective (B and L shares)

– Elite Access (no living benefit rider)

No living

benefits

Market share in VA business has shifted significantly as interest rates continue to remain depressed

Historical sales market share of top VA writers

5

Commentary

• In 2011, MET gained significant share

as weaker competitors retrenched

• PRU’s share declined in 2011 due to

price hikes and benefit cuts; this trend

reversed in 2012 as PRU regained

share and MET’s sales plummeted due

to management efforts to limit volumes

• In 2015, MET is projected to gain

market share and PRU is projected to

continue to lose market share

• Jackson National’s market share

continues to increase, with Lifeguard

Freedom Flex becoming best selling

GLWB product in market

• Lincoln has been more aggressively

selling VAs since 2013, driving up

market share

DAC

GAAP

value of

guarantee

fees

SOP 03-01

guarantees

10.7% 11.4%13.8% 14.8%

17.0%

4.5%5.2%

6.1%8.6%

9.4%

6.5%6.1%

7.3%

10.1%

9.6%

2.8%3.4%

3.7%

6.0%

7.4%

15.8% 13.2%

13.9%

8.1%

7.3%13.4%18.5%

12.3% 7.5%4.7%

0%

10%

20%

30%

40%

50%

60%

2010 2011 2012 2013 2014

Sa

les

ma

rke

t s

ha

re

Jackson National Life AIG Am Gen/VALIC Lincoln National

Aegon/Transamerica Prudential Financial MetLife


VA AUM forecasted to grow 6-7% annually in the long run

AUM market share of top living

benefit VA writers (3/31/15)

6

Commentary• AUM growth in the VA business is heavily dependent

on equity market movements but tends to be less volatile due to allocations to fixed income investments

• At 3/31/15, 72% of VA AUM was allocated to equity and balanced funds (similar to the high point level of 72% reached in 3Q07), with the remaining 28% in fixed income and cash

DAC

GAAP

value of

guarantee

fees

SOP 03-01

guarantees


9.1%

7.9%

7.0%

6.1%

5.5%5.3%

3.9%3.5% 3.5%

MetLife PrudentialFinancial

JacksonNational

LincolnNational

AXA Financial AIGSunAmerica

AmeripriseFinancial

Voya / Reliastar Aegon /Transamerica

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

AU

M M

ark

et

Sh

are

of

As

se

ts (

3/3

1/1

5)

• Although large fixed income allocations help reduce volatility, it becomes more challenging for assets to grow at guaranteed levels in a prolonged low rate environment

IMPACTS TO / RESPONSES OF VA WRITERS TO LOW INTEREST

RATE ENVIRONMENT

Executive Summary

Impacts to and responses of VA writers to low interest rate environment

Dimension Impact of low interest rate environment VA writer responseImpact of response

A New business

Maintaining same new business volumes becomes onerous on balance sheet

Curb distribution of VA sales until interest rates mean revert to long term levels

Expectation of rising interest rates has allowed for VA writers to consider developing riskier products at same prices

Maintain “rational” products in market, with appropriate equilibrium between benefits and fees

B Product

De-risking of VA product designs, benefits and fees due to persistent low interest rate environment

Fundamental VA product de-risking mechanisms have been implemented into current products

Greater consistency in product features over last 2-3 years

Highlights lack of a stable relationship between reserves and capital

NAIC is investigating changes to harmonize statutory framework for VA products

TBD

C ProfitabilityProduct de-risking has increased GAAP ROEs to low to mid teen levels for new business

VA writers are not appropriately risk-adjusting new business ROEs, since cost of hedging is not incorporated in net income

D Reinsurance markets

Higher new business margins from de-risked products have opened up VA reinsurance markets

VA writers are actively engaged in VA reinsurance deals

E Divestiture strategies

In conjunction with regulatory uncertainty, low interest rates have helped drive divestiture strategies of VA blocks

Recent M&A activity around VA blocks have involved foreign acquirers

Provide compensation to policyholder in exchange for product (exchange offer)

F Alternative products

Decelerate VA sales and pivot distribution network to alternative products

Increased sales of FIA w/ GLWB riders and Deferred Income Annuities

Significant impact to VA writer Insignificant impact to VA writer8

New business

IMPACT 1: Maintaining same new business volumes becomes onerous on balance sheet

Low interest rate environment causes significant impacts to balance sheet

DimensionImpact of Low Interest Rate

EnvironmentDownstream Impacts

Balance

Sheet Impact

1Statutory

Reserves /

Capital

• While statutory reserve levels are relatively

interest rate insensitive, lower rates will increase

volatility of required capital requirement

• Higher cost of capital

• Limited opportunities to earn returns on other

products

2 Claims• Increase in GAAP reserves (FAS 157) from

claims being discounted at lower rates• Lower net income

3 Cost of hedging• Higher cost of hedging as options become more

expensive• Reduces incentive to fully hedge interest rates

4Assets

supporting fixed

funds

• Increased difficulty in supporting rates in fixed

account due to spread compression in general

account

• Disintermediation risk

5 Profitability• Lower ROEs due to lower net income from higher

reserve levels

• Opportunity cost of earning higher ROEs on

other products

A B C D E F

Significant impact to balance sheet Insignificant impact to balance sheet9

New business

RESPONSE 1: Curb distribution of VA sales until interest rates mean revert to long term levels (1/2)

VA Sales vs. 10-year Treasury rate

10

Commentary

• Weak empirical correlation between

VA sales and interest rates

• While not primary driver, low

interest rate environment has

contributed to drop in VA sales

(supply-side effect)

• Onerous impacts of low interest

rate environment has caused

conscious de-emphasis on

distribution of VA products

• VA sales expected to marginally

decrease (year-over-year) in 2015,

as rates have fallen further

DAC

GAAP

value of

guarantee

fees

SOP 03-01

guarantees

Industry sales have dropped steadily

over 2012 – 2014 and are expected to

fall marginally (1%) in 2015

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

0

50

100

150

200

VA

Sa

les

($

bn

)

Total Industry Sales ($BN) (left) 10-year Treasury (mid-year) (right)

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

YO

Y s

ale

s c

ha

ng

e

A B C D E F

New business

RESPONSE 1: Curb distribution of VA sales until interest rates mean revert to long term levels (2/2)

U.S. 10-year Treasury Security Yield: A Long

Downward Trend, 1990 – 2015*

11

Commentary

• We have been in a low interest rate

environment for the last decade

• Interest rates have not recovered to

pre-financial crisis levels

• Artificially low interest rate

environment expected to continue

through 2015 and 2016DAC

GAAP

value of

guarantee

fees

SOP 03-01

guarantees

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Yields on 10-Year U.S. Treasury

Notes have been essentially

below 5% for a full decade U.S. Treasury

yields plunged to

historical lows in

2013, rebounded,

and then fell

again

Recession

* Monthly, constant maturity, nominal rates, through September 2015

Sources: Federal Reserve Bank at http://federalreserve.gov/releases/h15/data.htm. National Bureau of Economic Research (recession dates)

A B C D E F

http://federalreserve.gov/releases/h15/data.htm

New business

IMPACT 2: Expectation of rising interest rates has allowed VA writers to consider developing riskier products at same prices

12

U.S. interest rate forecast: 2015 - 2021 Commentary

“Normalization” of interest rates is

unlikely until 2018 or later, a decade

after onset of global financial crisis

Impact of higher expectation of

interest rates on VA products:

– Lower volatility in required capital /

cost of capital

– Lower present value of projected

claims

– Lower cost of interest rate hedges

– Stronger risk-adjusted ROEs

• VA writers “betting” on rising interest

rates in 2016 have considered

developing more generous products

at same prices to increase sales

and improve market share

2.3

2.9

3.9

4.2 4.3 4.3 4.3

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

15F 16F 17F 18F 19F 20F 21F

Yie

ld (

%)

Forecast Year

Sources: Blue Chip Economic Indicators

The end of the Fed’s Quantitative

Easing program in 2014 and a

stronger economy have yet to

push longer-term yields higher

A B C D E F

New business

RESPONSE 2: Maintain “rational” products in market, with appropriate equilibrium between benefits and fees

Benefit features vs. fees of top selling

B-share GLWBsCommentary While outliers exist, top selling GLWBs

generally maintain a correlation between benefit richness and fees

All GLWBs are not “de-risked,” in particular JNL’s LifeGuard Freedom Flex, which affords wide array of investment options and option of a 7% roll-up rate

Of top 25 GLWB’s, all offer a roll-up rate, exception is Pacific Life’s Core Income Advantage Select rider

5% lifetime withdrawal rate starting at age 65 is industry norm

Annual step-up is industry norm;exception is Prudential’s Highest Daily Lifetime Income 3.0 rider

JNL, PRU, MET and LNC have been active in the L-share market, but B-share design is expected to be dominant design0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

0 1 2 3 4 5

To

tal V

A F

ee (

M&

E +

Rid

er

+ F

un

d)

Benefit Richness

Jackson National –

Perspective II – LifeGuard

Freedom Flex1

Prudential Financial –Premier VA – Defined

Income – Benefit

Pacific Life – Pacific Choice – Core Income

Advantage Select

Lincoln National –American Legacy –

Lifetime Income Advantage 2.0

Lincoln National –ChoicePlus Assurance

– Lifetime Income Advantage 2.0

Prudential Financial –Premier VA – Highest Daily

Lifetime Income 3.0

TransAmerica –Variable Annuity –Retirement Income

Choice 1.6

Nationwide Financial – Destination 2.0 –

Lifetime Income Rider

Benefit richness is composite score based on weighted average of following variables:• Withdrawal rates by age

• Roll-up rate

• Roll-up length

• Step-up rate / frequency

• Asset allocation criteria

• Fund selection / fund types

1. Based on 6% roll-up option (5%, 6%, or 7% options offered)

A B C D E F

13

Product

IMPACT 1: De-risking of VA product designs, benefits and fees due to persistent low interest rate environment

14

Dimension Impact of Low Interest Rate Environment Product de-risking mitigation

1Statutory

Reserves /

Capital

• While statutory reserve levels are relatively interest rate

insensitive, lower rates will increase volatility of required

capital requirement

• Higher fees and lower claims will decrease projected

Accumulated Deficiencies, lowering statutory reserve and

Total Asset Requirement levels

2 Claims• Increase in GAAP reserves (FAS 157) from claims being

discounted at lower rates

• Reduced benefit and higher fees will reduce GAAP reserve

• Prescribed allocation to volatility managed funds will mitigate

volatility in GAAP reserve

3Cost of

hedging

• Higher cost of hedging as options become more

expensive• NA

4Assets

supporting

fixed funds

• Increased difficulty in supporting rates in fixed account

due to spread compression in general account• NA

5 Profitability• Lower ROEs due to lower net income from higher reserve

levels• Streamlining benefits and fees generates higher ROEs

A B C D E F

VA product de-risking cannot fully mitigate impact of low interest rate environment

Product

RESPONSE 1a: Fundamental VA product de-risking measures have been implemented into current products (1/2)

De-risking measures Description

1 Higher fees • Increase M&E and rider fees of product

2 Lower benefits

• Reduce roll-up rate

• Move to simple interest for roll-up rate

• Eliminate or reduce frequency of reset feature

• Reduce guaranteed withdrawal rates at attained ages

3 Stricter asset allocation limits • Higher mandatory minimum allocation to fixed / balanced accounts

4Mandated automatic subaccount

rebalancing• Reduces ability of policyholders to “time the market”

5 Reduction in fund options • Restriction in number of equity funds available in sub-accounts

6 Increased use of index funds • Increased use of “tracker” equity and bond funds in subaccounts

7Shifting of hedging costs to

customers

• Partial shifting of hedging costs to customers by requiring allocations to funds that embed

interest rate hedging within fund

8 Augmented hedging strategies• Increased use of volatility hedging

• Adding macro hedges to protect against steep interest rate drops

A B C D E F

15

Product

RESPONSE 1a: Fundamental VA product de-risking measures have been implemented into current products (2/2)

16

Macro view of VA product de-risking

(pre-crisis and post-crisis)

Commentary

Most insurers have raised fees and

lowered guarantee levels in recent

years to mitigate the impact of low

interest rates

While a handful of companies

(Aegon, MetLife) have reduced fees

and introduced more generous

benefits recently, overall

terms/conditions remain rational and

prices/guarantee levels offered

currently are significantly more

conservative than those offered prior

to the financial crisis

Historically, price competition in the

VA business has been pro-cyclical,

more rational following market

downturns and aggressive after

recoveries

Prior

Feature

(2008)

Fee Accum.With-

drawal

Current

Feature Fee Accum.

With-

drawal

AMP SecureSource 0.65% NA 6.0% SecureSource4 1.25% 6% 3.0%-6.0%

AXA GWB for Life 0.65% 7.0%4.0%-

7.0%GMIB 1.15%

4.0%-

8.0%4.0%-8.0%

HIG

Lifetime

Income Builder

Selects

0.55% NA5.0%-

8.0%Not actively selling VAs

LNCi4LIFE

Advantage0.40%

3.0%-

6.0%NA

Lifetime Income

Advantage 2.0 1.05% 5%

3.5%-

5.0%

MFCPrincipal Plus

for Life0.40% 5.0% 5.0% Not actively selling VAs

MET GMIB Plus 0.80% 6.0% 6.0% Flexchoice 1.20% 5% 4.0-5.75%

NFS L-Inc 0.70% 7.0%4.0%-

7.0%

7% Lifetime

Income Rider 1.20% 7% 3.0%-6.0%

PL SecurePay 0.70% 7.0% 7.0% SecurePay 5 1.20% 5% 5.0%

PRU HD Lifetime 7 0.60% 7.0%5.0%-

8.0%

HD Lifetime 3.0

rider 1.00% 5% 2.9%-5.9%


A B C D E F

Product

RESPONSE 1b: Greater consistency in product features over last 2-3 years

17

2013

Rank

2014

RankCompany Contract

2013

Mkt. Sh.

2014

Mkt. Sh.

2 2 Jackson National Perspective II 7.0% 7.6%

4 3 Jackson National Perspective L 3.6% 4.0%

NA 5 Prudential

Financial

Premier B series NA 3.4%

5 6 Ameriprise RVS RAVA5

Advantage

2.8% 2.8%

12 7 AXA Equitable Ret. Cornerstone

13.0 (B)

1.8% 2.6%

6 8 AIG/VALIC Portfolio Director 2.7% 2.6%

9 9 AIG/AmGen Polaris Platinum III 2.1% 2.6%

13 10 Nationwide Destination 2.0 (B) 1.8% 2.3%

20 11 Transamerica TA Variable Annuity

B

1.1% 2.2%

11 12 Thrivent Flexible Prem. DVA

2005

1.9% 2.1%

Market share of sales for top selling living

benefit variable annuity contracts in 20141Commentary

Product features of most popular VA

products have stayed relatively

consistent through last 2-3 years, with

exception of marginal increase in fees

for some products since 2012

Consistency in product features

evidenced by relatively stable market

share of top selling living benefit

products

1. TIAA-CREF’s Retirement & Supplemental Retirement and JNL’s Elite Access both do not have living benefits and were excluded from list

A B C D E F

Illustrative VA portfolio

Reserves

Calculated as the larger of:

• Greatest pre-tax deficit in the worst

30% of scenarios in a stochastic

simulation

• Results from the “AG 43 Standard

Scenario,” which prescribes a market

decline and actuarial assumptions

– Differs from C3P2 Standard

Scenario for TAR

Reserves

Required

Capital

Total Asset Requirement (TAR)

Calculated as the larger of:

• Greatest post-tax deficit in the

worst 10%

of scenarios in a stochastic

simulation

• Results from the “C3P2

Standard Scenario,” which

prescribes a market decline

and actuarial assumptions

– Differs from AG 43 Standard

Scenario

Product

IMPACT 2: Highlights lack of a stable relationship between reserves and capital

18

Volatility in required capital exacerbated by low interest rate environment

• Different frameworks used to calculate TAR and reserves

• Interest rate sensitivity of TAR and reserves is not consistent (reserves are largely insensitive to

interest rate changes)

• Impact of differential sensitivity magnified in low rate environment

A B C D E F

Boundary between reserves

and capital

Product

RESPONSE 2: NAIC is investigating changes to harmonize statutory framework for VA products

19

• The NAIC enacted its C3 Phase II (“C3P2”) standard for capital charges in 2006, followed by AG43 in 2009

• Managing competing objectives of GAAP and statutory frameworks in low interest rate

environment has been a driver for the use of captives for VA products

• Recognizing the challenges posed by statutory capital management, NAIC commissioners have

pragmatically tried to accommodate the use of captives, while upholding sound standards of prudential

supervision

• The NAIC commissioned an initiative to identify changes to the statutory framework that will mitigate or

remove the motivation for insurers to use captive reinsurance and provide an incentive to recapture

exposures into the primary entities

A B C D E F

Profitability

IMPACT: Product de-risking has increased GAAP ROEs to low to mid-teen levels for new business

20

VA GAAP ROE – In-force vs. new business Commentary

• Product de-risking due to low

interest rate levels has created

healthier margins for new business

• Common to see reported GAAP

ROEs in low to mid teens (%) for

new business, largely driven by de-

risked product features and

increasing equity marketsNew business ROEs

significantly higher

than in-force ROEs

due to de-risking

strategies

5%

8%

0%

2%

4%

6%

8%

10%

12%

14%

GAAP ROE in-force GAAP ROE new business

VA

GA

AP

RO

E

A B C D E F

Illustrative

Profitability

RESPONSE: VA writers are not appropriately risk-adjusting new business ROEs, since cost of hedging is not incorporated in net income

21

5%

-3%

1%

8%

11%

0%

2%

4%

6%

8%

10%

12%

14%

GAAP ROE in-force

GAAP ROE newbusiness

Risk-AdjustedGAAP ROE

Risk-AdjustedGAAP ROE(reflectinglower Rho

hedge target)

Final risk-adjusted GAAP

ROE newbusiness

VA

GA

AP

RO

E

VA GAAP ROE Waterfall

New business

ROEs

significantly

higher than in-

force ROEs due

to de-risking

Cost of interest rate

hedging is not

reflected in net

income, thus

overstating risk-

adjusted return

Many companies

have lowered Rho

hedging target in

current interest

rate environment,

due to cost

Commentary

• Interest rate hedging is more

expensive when rates are low

– Put options are more expensive

– Pay-fixed / receive-floating swaps

lose market value

– Difference between real-world and

risk neutral rates becomes larger

(one approximation for cost of

hedging)

• Net income used in calculating ROE

does not reflect cost of hedging; thus

reported ROEs do not provide a risk-

adjusted return

• Risk adjusting reported ROEs

reduces ROEs by 2-3%

• VA writers may opt to significantly

reduce or eliminate interest rate

hedging if rates fall further

A B C D E F

Illustrative

Reinsurance markets

IMPACT: Higher new business margins from de-risked products have opened up VA reinsurance markets (1/2)

22

A B C D E F

Markets Description

1 Reinsurers

• Highly rated reinsurers are increasingly inquisitive about VA risks due to following reasons:

– Improved transparency around policyholder behavior frameworks

– Improved transparency around GAAP/IFRS profitability targets

– Industry emphasis on “sustainable products” with healthy risk-adjusted profitability margins

– Increased potential for diversification

2 Banks

• High margins of new business are primary driver of VA rider coinsurance deals

– Union Hamilton / Wells Fargo are largest reinsurer of VA riders

– Other banks are entering market of fully coinsuring VA rider risks (both capital market and actuarial

risks)

– 4-5 banks in market are capable of coinsuring VA rider risks

– Several VA reinsurance deals are currently in the works

Reinsurance markets

IMPACT: Higher new business margins from de-risked products have opened up VA reinsurance markets (2/2)

Time range Supply Description Major productsComplexity of

reinsurance

1 1990s• GMDB reinsurance was commonplace (CIGNA was one

of original GMDB reinsurers)GMDB

2 2000-2002• VA reinsurance dried up with “dot com” recession, as

reinsurance premiums increased drasticallyGMDB, GMIB

3 2006-2007• Reinsurers entered market as equity markets were rising

and interest rates remained at relatively high levelsGMIB, GLWB

4 2008 - 2009• Reinsurance market ceased to exist during global

financial crisisGMIB, GLWB

5 2009 - 2014 • Reinsurance market grew slowly post financial crisis GMDB, GMIB, GLWB

6 Present

• Banks and newer reinsurers have expressed interest in

both capital market risks and actuarial risks in VAs

• Higher margins from new business has increased the

supply of reinsurers to (1) hedge capital market risk and /

or (2) coinsure all the risks in VA products

GMDB, GMIB, GLWB

A B C D E F

23

Reinsurance markets

RESPONSE: VA writers are actively engaged in reinsurance deals (1/3)

24

StructureRisks

coveredPros to cedant Cons to cedant

Examples in marketplace

1Quota share of

rider only

All VA risks

(actuarial and

capital market)

• Higher profitability metrics (GAAP

ROE / Statutory IRR) since all (or

large portion) of M&E fee is retained,

while riskiest part of contract (rider) is

reinsured

• De-risking of balance sheet

• If rider fee does not have

sufficient margins/PADs,

reinsurers will have difficulty

meeting profitability targets

• No expense allowance to help

fund acquisition expenses /

commissions, since expenses

and commissions are normally

allocated to M&E fee

Union Hamilton (Wells

Fargo)

2Capital market

reinsurance with

retrocession of

actuarial risk

All VA risks

(actuarial and

capital market)

• Bi-furcation of capital market

reinsurance with actuarial

reinsurance via retrocessionaire

• Reinsurance premium pricing

is typically not as efficient as

full risk transfer / quota share

option

Majority of banks entering VA

reinsurance market

Most common industry practice

A B C D E F

Reinsurance markets


25

Illustrative

Cedant –

General

Account

Cedant –

Separate

Account

Reinsurer

x% GLWB claims

Registered

Investment

Company

Revenue sharing

GLWB

claims

Admin/

Surrender

charges

Annual Reinsurance Premium

x% of rider fee

Separate account

reinsurance reserve

• Modified coinsurance

basis

Presence of trust

is negotiated

between cedant

and reinsurer

Structured / Dynamic Hedging

Distribution

Commissions

Single

Premium

M&E

FeeRider

Fee

12b-1 fees

Policyholders

A B C D E FKey considerations

• Use of intermediary

reinsurer is necessary if

reinsurer is not legal

insurance / reinsurance

entity (e.g., investment

bank)

• 50% - 75% coinsurance

seen in industry

Reins

Premium

Reins

Claims

ModCo

Reinsurance markets


26

Ins CoInsurance

Captive

Regulation 114 Trust:

• held on-shore by

cedant due to

agreement being

ModCo

Reinsurer

Captive

Reinsurer

Retrocession

Definition of “risk”

transferred

All underlying

liabilities transferred

to captive

Reinsurance of

actuarial risks

A B C D E F

Illustrative

Increased

rating agency

scrutiny

Impact capital

requirements /

management

Additional capital

requirements

Lower ROE

Regulatory

ImplicationsNew capital rule

uncertainty

Impact dividends/

share buybacks

Increased

regulation

Impact M&A

activity

New

regulations

Reduce

investment

returns

27

Divestiture strategies

IMPACT: In conjunction with regulatory uncertainty, low interest rates have helped drive divestiture strategies of VA blocks

A B C D E F

Commentary

• Uncertainty in regulatory

implications around capital

levels has impact on M&A

activity

• VAs are considered “non-

core” business line by certain

regulatory bodies

• Low interest rate

environment is just one of

the drivers of M&A activity

Pertains to low interest rate environment


RESPONSE 1: Recent M&A activity around VA blocks have involved foreign acquirers

Source: SNL Financial, Company Filings, J.P. Morgan Research

Date Announced Target NameAcquiror

NameValue ($M) Price / Book Value

Aug-15 3,730 1.56x

Jun-14 5,580 1.29x

Sep-13 650 1.24x

Dec-12 1,550 NA

Dec-12 1,350 0.62x

28

A B C D E F

Commentary

• Japanese acquirers have dominated M&A market over last 18 months

• Even lower interest rate environment in Japan

• Lack of alternative investment vehicles in Japan for capital

• Difficulty in growing reserve / capital base due to declining population in Japan

• Diversification into US markets / demographics

• Over 2012 – 2013, VA transactions were dominated by PE firms


RESPONSE 2: Provide compensation to policyholder in exchange for product (exchange offer)

Assessment of exchange offer target

Size / Homo-geneity

Mitigating adverse selection

Variance in economic vs

perceived value

Overall assessment

for offer target Commentary

Old

er

des

ign

s

Guaranteed Minimum Death Benefit

• Subject to anti-selection if policyholders have non-uniform health status• Typically have low perceived value compared to economic value, in

particular for enhanced death benefits• Enhanced death benefits are excellent offer targets

Guaranteed Minimum Accumulation Benefit

• Relatively homogeneous, with low expected lapse rates• Low perceived value compared to intrinsic value• Benefits that are past surrender charge and are close to expiry are

excellent offer targets

Mo

de

rn d

es

ign

s

Guaranteed Minimum Income Benefit

• Not homogeneous, as older regimes require election of annuitization not present in modern designs

• Target older regimes of income benefits that require election of annuitization, as perceived value is likely lower compared to more recent regimes

Guaranteed Minimum Lifetime Withdrawal Benefit

• Variety of designs makes product heterogeneous• Highly lapse supported product makes mitigating adverse selection difficult• High economic values (rich features) and high perceived values (lifetime

income desired) make for poor offer targets

A B C D E F

29Significant characteristics across dimension Some characteristics across dimension Minimal characteristics across dimension

Alternative products

IMPACT AND RESPONSEIncreased sales of FIA w/ GLWB riders and Deferred Income Annuities

30

Response

FIA w/ GMWBs

– Growing sales with strong guarantees

– Book value accounting benefits

– Longer surrender charges & some

with MVAs s VAs

– Less visible fees vs. VA

SPIAs & DIAs (IAs)

– DIAs gaining in sales, with more

companies offering

– With less equity accumulation

potential in VAs, increased appeal of

IAs with lower level of fixed

accumulation

Impact

Decelerate VA distribution

Pivoting of distribution networks to alternative

insurance products

A B C D E F

APPENDIX

ProductIMPACT 2: Highlights lack of a stable relationship between reserves and capital

TAR Reserves Standard scenarioLegend: 32

A B C D E F

Total statutory funding required

MAX

Total Asset Req.

(C3P2)Reserves (AG43)

C3P2 Standard

Scenario Amount

C3P2 Stochastic

Amount

AG43 Stochastic

Amount

AG43 Standard

Scenario Amount

CTE 90

“Adjusted” C3P2

run not reflecting

hedge rebalancing

CTE 70

“Best-efforts” AG43

run reflecting hedge

rebalancing

CTE 70

“Adjusted” AG43 run

not reflecting hedge

rebalancing

Difference, if positive,

is the RBC C3 charge

MAX MAX

CTE 90

“Best-efforts” C3P2

run reflecting hedge

rebalancing

Weighted avg. Weighted avg.


33

A B C D E F

AG43 Stochastic C3P2 Stochastic

Tail measure CTE 70

Equity scenariosEither pre-packaged scenarios (e.g., from the AAA) or alternative real-world scenarios meeting

specified calibration criteria

Interest rate scenarios No explicit rules – in particular, the long-term mean reversion parameter is unspecified

Reflection of hedging

Weighted average (based on the “E factor”) of two separate runs:

• “Best-effort”: reflects the company’s actual hedging practices, with rebalancing

• “Adjusted”: currently-held hedges are run off, but no hedge rebalancing is permitted

“E-factor”: reflection of hedging

effectiveness

• 30% to 70%

• 100% if hedging increases reserves

• 30% to 90%

• 100% if hedging increases TAR

Behavioral assumptions Prudent best-estimate behavioral assumptions

Revenue sharing reflectionRevenue sharing reflected based on company expectations subject to limitations on non- guaranteed

amounts

Diversification Allows for full in-force diversification

Tax Treatment Pre-tax Post-tax


34

A B C D E F

AG43 Standard Scenario C3P2 Standard Scenario

Standard scenario measure Greatest present value of accumulated net revenue (“GPV ANR”)

Equity scenarios

• Immediate 13.5% decline

• 0% returns for the first year

• 4% return from years 2-5

• 5.5% return from year 6 onward

• Immediate 20% decline

• 0% returns for the first year

• 3% return from year 2 onward

Interest rate scenarios

• Locked-in rate specified by the SVL – constant

throughout projection

• No consistency with CTE discount rates

• Specified as 10-year UST + 50 bps – constant

throughout projection

• No consistency with CTE discount rates

Reflection of hedging No hedge rebalancing permitted; all currently-held hedges are liquidated after one year

Behavioral assumptions• Prescribed, often unrealistic assumptions

• Some differ from C3P2 SS assumptions

• Prescribed, often unrealistic assumptions

• Some differ from AG43 SS assumptions

Revenue sharing reflection Revenue sharing limited

Diversification Conducted only on a seriatim basis Allows for full in-force diversification

Tax Treatment Pre-tax Post-tax

Variable Annuity Products: Responding to a Low Interest ... · PDF fileVariable Annuity...

Documents

Transcript of Variable Annuity Products: Responding to a Low Interest ... · PDF fileVariable Annuity...