annuity capital risk managment ne act nov 2012

Annuity Capital Risk ManagementActuaries’ Clubs of Boston and Hartford & Springfield

Kendrick Lombardo FSA, MAAANovember 15, 2012

© 2012 Towers Watson. All rights reserved.

Agenda

Economic environment FIA capital risk management issues VA capital risk management issues Summary

AGENDA

© 2012 Towers Watson. All rights reserved.2

Economic Environment


Very low interest rates are the most significant capital risk management challenge facing the industry

Pressure on new products (all annuities) Risk increase on lapse supported products (e.g., GLWB) Increased cost of VA hedging and general account ALM challenges for FIA

4© 2012 Towers Watson. All rights reserved.

ECONOMIC ENVIRONMENT

FIA Capital Risk Management


The risk management of FIAs is subject to multiple inputs and constraints

Riders ALM

Hedging?

U.S. Statutory AG 33 / 35

State specific?

U.S. GAAP FAS 133 / 157

SOP 03-1

Base Contract Cap management

ALM

Hedging

GLWB statutory reserving in a low rate environment is a critical FIA capital management issue

Fixed Indexed

Annuities

FIA CAPITAL RISK MANAGEMENT


Guaranteed FIA GLWB income rates


Average of effective withdrawal rates (includes impact of bonuses and rollups) for 1) issue age 55, wait 5 years, 2) issue age 65, immediate 3) Issue age 60, wait 5 years and 4) Issue age 60, wait 10 years

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Guaranteed FIA GLWB income rates reduced

Average of effective withdrawal rates (includes impact of bonuses and rollups) for 1) issue age 55, wait 5 years, 2) issue age 65, immediate 3) Issue age 60, wait 5 years and 4) Issue age 60, wait 10 years© 2012 Towers Watson. All rights reserved.

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Capital management actions taken by FIA carriers

Product changes Commission decreases Premium bonus decreases Income rate decreases Rollup rate decreases / making rollup simple interest

Pursuing new statutory reserving regimes AG 43 (standard scenario & stochastic) Modified AG 33 (e.g., add low lapses)

Enhancing ALM capabilities Improving GLWB assumptions

Refinement of dynamic lapses, withdrawals, waiting periods and mortality Modifying hedging programs

Account for GLWB at a macro level Refinement of index hedge programs

Merger & Acquisition (M&A) activity



VA Capital Risk Management


Capital risk management issues in VA market

Low interest rates Impact on equity sensitivity of AG 43 reserves and C3P2 capital Rho hedges can create exposure to rising interest rates on a statutory basis Make impact of policyholder behavior more significant

Companies are working on a number of fronts to improve their capital risk management Reflection of hedging in financial projections Reflection of statutory reserves / capital projections Refining policyholder assumptions Product designs changes

Other developments Benefit buyouts Renewal premium limits M&A


VA CAPITAL RISK MANAGEMENT

Reflection of hedging in financial projection models

Hedging approach generally impacted by a number of factors, including: Accuracy of results Complexity of implementation, validation, inputs and analysis Computational demands (software and hardware)

Range of industry practice is shown below

Accuracy

Sophistication

Reinsurance Approach

Change in Liabilities Approach

Proxy for Hedging Transactions

Explicit Projection of Hedging Transactions

We believe the industry has shifted towards using more explicit projections of hedging transactions

Simpler methods still remains popular, given the complexity of projecting hedging transactions, but they have their limitations



Reflection of reserves and capital in projection models

Less refined More refined

Develop set of factors

May vary based on

Product feature

Duration

ITM

Real-world scenarios

Considerations

Number of scenarios

Time steps

Final analyses only?

Factor Based ApproachesStochastic-on-Stochastic

Other possibilities:

Standard scenario only

Focus on TAR only

Advanced techniques



Policyholder Behavior

Policyholder behavior has caused large surprises Many companies are working on enhancing their capabilities

Data– Inforce extracts– Transaction/exposure data for experience analysis

Techniques– Predictive modeling

Granularity of financial models There is still significant variation in the industry A significant issues are

Interest rate related behavior for GLWBs Dynamic lapse rate slopes Floor lapse rates Non-user withdrawal cohorts and their other behavior



Summary


Summary

Low interest rates pose significant challenges on all fronts for both variable and fixed annuities

Profitability is becoming more dependent on policyholder behavior Enhancement of methods for measuring and monitoring experience is

becoming critical for many Better financial modeling is required

More granularity for policyholder behavior assumptions Projection of management actions (investments, hedging, credited rate

setting) and their limits Accurate refresh of balance sheet to understand capital risk exposures Ability to refine attributions of actual results

SUMMARY


Questions

SUMMARY


annuity capital risk managment ne act nov 2012

Documents

towers watson

issue age

rates impact

c3p2 capital rho hedges

glwb statutory reserving

statutory basis

statutory fas

va marketlow