Session 74 PD, Indexed Product Update. Moderator: Robert P. Stone, FSA, MAAA

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Session 74 PD, Indexed Product Update

Moderator:

Robert P. Stone, FSA, MAAA

Presenters:

Guillaume Briere-Giroux, FSA, MAAA

Robert P. Stone, FSA, MAAA

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Guillaume Briere-Giroux, FSA, MAAA, CFA

Fixed Indexed Annuity Market Update

2014 Life and Annuity Symposium

Atlanta – May 20, 2014

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Agenda

I. Market dynamics

II. Product trends

III. Pricing, valuation and risk management issues

IV. Watch list

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Market dynamics

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Annuity sales trends (2007-2013)

Fixed indexed annuities (FIAs) are now firmly established as the second largest

annuity segment

Variable Indexed MVA Book value SPIA DIA

Sales data from LIMRA

Market risk for policy holder Lower Higher

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Indexed annuity sales trends (2001-2013)

FIA sales have grown at a robust 7.8% annual rate since 2007

Source: Wink’s Sales & Market Report (2006 and prior) and LIMRA (2007 and later)

$ Billions 6.8 11.8 14.4 23.1 27.2 25.3 _25.0 26.7 29.9 32.1 32.2 33.9 39.3 0 5 10 15 20 25 30 35 40 45 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 7.8% CAGR

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Symetra

Competitive landscape (2013)

Today’s FIA market has a broad range of players with increasing representation

outside of the independent channel

Source: Wink’s Sales & Market Report and Oliver Wyman Research

Phoenix

Banks and wirehouses Independent and banks Independent organizations Priv ate Equity _Ow ned US Stock _Companies Foreign Subsidiaries Mutual Companies O w ne rs hip Structure

Lower Credit Rating Higher A++ A A-B++ B+ B

Market share and dominant distribution channels by ownership structure and credit rating

Priv

ately

Held

Career

Size of bubbles represents 2013 market share

Primary distribution channels

A+ Allianz Life Sagicor Life Jackson National Security Benefit American Equity Great American EquiTrust Athene Fidelity & Guaranty Life North American Midland National

Lincoln Benefit Life VOYA Genworth AIG National Western Lincoln Protective Life CNO Companies

Pacific Life Nationwide

OneAmerica Western & Southern All other companies Forethought

National Life Group

15.5 10.4 11.7 7.1 7.9 % % % % %

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AmerUS

(Aviva USA / Athene Block) ING (Now VOYA)

Competitive landscape (2005)

The FIA market was previously heavily concentrated in “niche players” focusing on

the independent channel

Source: Advantage Compendium and Oliver Wyman Research

Banks and wirehouses Independent and banks Independent organizations Priv ate Equity _Ow ned US Stock _Companies Foreign Subsidiaries Mutual Companies O w ne rs hip Structure

Market share and dominant distribution channels by ownership structure and credit rating

Priv

ately

Held

Career

Primary distribution channels

A+ Allianz Life

Jackson National

American Equity EquiTrust

Midland National Jefferson Pilot (Now Lincoln) Sun Life (Now Delaware Life) All other companies % % Old Mutual (Now Fidelity & Guaranty Life) 15.2 8.7 32.3 8.8 9.9 7.5 % % % % % %

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Recap of trends in market players and distribution

1 Foreign subs in retreat

2 Private equity gaining ground

3 Expansion in banks and broker dealers

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FIA market driving forces

Significant changes are being driven by the following key forces

Forces Description Sales New Entrants

/ Channels

M&A Activity

Changes in Domicile

Interest rates • Low interest rates are driving a “search for yield” and players

with alternative asset strategies are becoming prominent



Regulatory • Variations in how states apply reserve and capital requirements

• Solvency II and Canadian solvency requirements



Demographics / consumer needs

• Income riders make up ~65% of sales and 70% of agents consider them a “must have” (Phoenix survey)

• Baby boomers nearing retirement with significant wealth are

nearing “peak age” for FIA sales



Inforce blocks

• Most sales from 2004-2005 (peak years before introduction of FIA income riders) are about to exit the surrender charge period • This should propel sales in 2014-2015; we expect business

rolling off the books to be a more significant driver of FIA sales moving forward (as with the VA market)

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Economic conditions

FIA sales are benefiting from higher investment yields since mid-2013

Source: Federal Reserve of St Louis, Treasury data and BofA Merrill Lynch US Corporate Option-Adjusted Spreads

Select Bond Yields Credit and Maturity Spreads

Credit spreads are slightly above pre-crisis levels and the yield curve is steeper. This makes

FIAs comparably more attractive than alternatives such as fixed annuities (generally shorter

maturities) or CDs.

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Acquisitions by private equity / alternative buyers reshaped the FIA market

Acquirer/Seller (date)

*

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Many FIA carriers decided to re-domicile in the past year

Regulatory environment, pool of insurance expertise and operating costs are drivers

Relocation to Iowa announced January 2014 Relocation to Iowa announced November 2013 Relocation to Illinois announced January 2014

Decided to locate overall headquarters in Des Moines

(2013) and relocated jobs from Kansas (2014)

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Product trends

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Notable base contract features and trends

1

VA / FIA hybrids

• Can be VA or FIA by design

• Designs with floors less than zero, registered and no minimum contract value • Downside protection via “protection buffers” or “protection floors”

• Higher upside

• Short surrender charges

• Sellers include AXA, Allianz Life, MetLife

2

Volatility control indices

• Lower hedge cost allows uncapped upside

• Sellers include Security Benefit, Symetra, Allianz Life, Fidelity and Guaranty Life

3

Liquidity features

• Features that are not new but popular include • Return of premium

• Bailout provisions • Nursing home waivers

• Shorter surrender charge designs gained popularity

4

Other accumulation features

• “Buy up” the cap

• Rolling forward index credits

• Credits linked to change in interest rates • Guaranteed minimum values

Average commissions continue to decline, but much of this is driven by the popularity of

shorter surrender charge designs as opposed to changes in the interest rate environment

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Benefit riders

1

Indexed-linked income growth

• “Stacked” rollups (e.g. 4% + account value performance) • “Turbocharged” account value driving income

• Income increases after income start

2

Other variations in lifetime income structures

• Rollups are compound / simple / or absent (e.g., vary income rates by age / duration) • Limiting rollups / limiting younger issue ages common (AG 33)

• Less breakpoints in income bands

• More income options (flat, guaranteed increase or index-linked increases)

3

Nursing home income riders

• Offered for free or additional charge (e.g. 10 bps)

• Typically doubles the income for up to 5 years if cannot perform 2 of 6 ADLs • Becoming increasingly common

• Complex to price

4

Enhanced death benefits

• Offered with or without GLWB (sometimes for an additional charge) • Wait periods

• Maximum payout

• Payout periods / reduced lump sum

Benefit riders are the most important driver of sales for many carriers, but less so for carriers

focusing on distribution through banks

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Rider competiveness

The richness of GLWB riders and “extras” such as nursing home “doublers” and

GMDBs correlates fairly well with market share changes

Decreasing market share Increasing market share Stable market share

Rider

Composite Richness

Index*

Market share and market share changes by credit rating and rider richness

Market share changes

A+ Company E Company G Company D Company B Company A Company C Company F

Source: Wink’s Sales & Market Report and Oliver Wyman Research

Rating / rider richness “equivalent” line

*Rider composite richness index includes allowance for GLWB payouts, rider charges, presence of nursing home benefits and GMDBs.

This analysis does not factor commissions, distribution allowances or base credited rates.

Lower

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Pricing, valuation and risk

management issues

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Pricing, valuation and risk management issues

1 Pricing assumption checklist

2 Valuation and regulatory radar

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1. Pricing assumption checklist

1 Lapses

• Base rate + impact of GLB

• Policy year skew

• Dynamic rate (base contract)

• Dynamic rate (GLB in-the-moneyness driven)

2 Age Mix / GLWB

Election

• Utilization cohorts

• Utilization skew (feature driven)

• Utilization skew (attained age driven)

3 Mortality

• Base rate

• Mortality improvement

4 Management

Actions

• Crediting rate strategy

• Initial asset mix

• Reinvestment strategy

5 Economic

Assumptions

• Interest rates

• Credit spreads and default costs

• Equity performance

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2. Valuation and regulatory radar

AG 33 GLWB

statutory reserves

(in progress)

Valuation and capital for

FIA / VA hybrids (in

progress)

Solvency 2 (2016 or later)

VM-22 (2016)

Risk-based capital

(2014 updates)

2012 IAR table

(2014-2015)

IFRS 9 (2018)

US GAAP targeted updates (TBD)

NAIC Private Equity

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3. Risk management radar

ORSA (2015)

Dynamic lapses

Emerging GLWB

utilization experience

Low rate environment /

Federal Reserve actions

Inforce blocks

approaching end of the

surrender charge period

Hedging of GLWBs

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Watch list

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1 Interest rates

2 M&A

3 Statutory reserving

4 Risk management of riders

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Indexed Universal Life

Presented by

Rob Stone, FSA, Principal & Consulting Actuary

Rob.Stone@milliman.com

317-524-3534

May 20, 2014

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2

Agenda

Market Overview

The case for Indexed UL

Product Features

IUL Considerations

Indexed Modeling Complexities

IUL Case Study

Questions

May 30, 2014

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3

Market Overview – Life Products

May 30, 2014

Individual Life Insurance Growth Rates by Product

Percent Change 2012-2013

Annualized

Premiums

Face

Amount

Number

of Policies

Universal Life

Fourth Quarter

-23%

-27%

-16%

Year to Date

-7

-19

-16

Variable Universal Life

Fourth Quarter

36

24

25 Year to Date

24

17

12 Term

Fourth Quarter

-1

-3

Year to Date

3

1 +

Whole Life

Fourth Quarter

3 +

+

Year to Date

4Q 2000 Market Share of Annualized Premium

18%

36%

23%

UL

VUL/VL

Term

Whole Life

Source: LIMRA

May 30, 2014

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4Q 2013 UL Market Share of Premium

by UL Type

Source: LIMRA

May 30, 2014 2% 28% <<0% 7% 13% 18% 5% 27%

IUL-ULSG

ULSG

Term UL +

Other

IUL-CA

CA

Accum

IUL-Accum

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10

Life / Annuity Sales Drivers: Market Forces

0

2

4

6

8

10

12

14

16

18

20 Jan-80

Jan-82

Jan-84

Jan-86

Jan-88

Jan-90

Jan-92

Jan-94

Jan-96

Jan-98

Jan-00

Jan-02

Jan-04

Jan-06

Jan-08

Jan-10

Jan-12

Jan-14

10-Yr T (%)

S&P (100's)

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Indexed UL Sales (Total Life is 10B)

$65 $62 $63 $85

$100 $97

$140

$187

$352

$512 $539 $531

$695

$973

$1,314

$1,428

$0

$400

$800

$1,200

$1,600

1999

2001

2003

2005

2007

2009

2011

2013

Source: Total Sales – LIMRA; Indexed Sales - Wink’s Sales & Market Report 4th Quarter 2013

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Indexed UL Sales - 2013

Top 15 Companies

Rank

Company

Market Share

1 Pacific Life Companies 7 13.07% 2 AXA US 9.28 3 National Life Group (NL/LSW) 7.78 4 Aegon 7.34 5 Minnesota Life 5.79 6 Allianz Life 5.08 7 Prudential Companies 4.73 8 Zurich Life (est) 4.58 9 American General Life Companies 4.12 10 Aviva 3.71 11 Lincoln National Life 3.63 12 National Western 3.45 13 Midland National Life 3.21 14 Penn Mutual 3.19 15 Nationwide 3.13 May 30, 2014 Top 5 Combined: 43.26% Second 5 Combined: 22.22%

Source: Wink’s Sales & Market Report 4th Quarter 2013

2013 was the 4th

year in a row to

break the indexed

life sales record.

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Indexed UL Sales - 2011

Top 15 Companies

Rank

Company

Market Share

1 AXA Equitable 14.52% 2 Aviva 14.25 3 Pacific Life Companies 11.57 4 AEGON Companies 8.08 5 National Life Group (NL/LSW) 6.59 6 Minnesota Life 6.42 7 Penn Mutual 6.1 8 National Western 4.3 9 Midland National Life 3.73 10 Lincoln National Life 3.67 11 Allianz Life 3.66 12 American General Life Companies 2.81 13 Allstate Financial (LBL) 2.63 14 ING 2.60 15 North American Company 2.18 May 30, 2014 Top 5 Combined: 55.01% Second 5 Combined: 24.22%

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Indexed UL Sales - 2008

Top 15 Companies

Rank

Company

Market Share

1 Aviva 20.06 2 AIG American General 11.27 3 Pacific Life Companies 10.05 4 National Life Group (NLV/LSW) 9.19 5 AEGON Companies 8.51 6 Old Mutual Financial Network 6.74 7 Allianz Life 6.22 8 Midland National Life 2.76 9 Allstate Financial (LBL) 2.76 10 Phoenix Life 2.53 11 Penn Mutual 1.87 12 ING 1.62 13 Minnesota Life 1.58 14 National Western 1.46 15 Union Central Life (UNIFI) 1.24 May 30, 2014 Top 5 Combined: 59.08% Second 5 Combined: 21.01%

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Indexed UL Sales - 2006

Top 14 Companies

Rank

Company

Market Share

1 AVIVA 37.43% 2 AEGON Companies 11.03 3 National Life Group (NLV/LSW) 9.89 4 AIG American General (est) 9.02 5 Old Mutual Financial Network 8.30 6 Allianz Life 6.08 7 Pacific Life Companies 6.07 8 Midland National Life 4.40 9 Conseco 3.56 10 Lafayette Life 2.13 11 National Western 1.42 12 Union Central Life (UNIFI) 0.61 13 Minnesota Life 0.03 14 North American Company (est) 0.02 May 30, 2014 Top 5 Combined: 75.67% Second 5 Combined: 22.24%

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Indexed UL Sales - 2013

Top Characteristics of 4

th

Quarter Sales

May 30, 2014

Source: Wink’s Sales & Market Report 4th Quarter 2013

 52 Carriers Offering Product

 Crediting Method

– Annual Point-to-Point ……… 73.9%

 Index

– S&P 500…………..………..…..…..71.5%

– Rainbow/Multi-Index………21.5%

– Other (including Fixed)……….…....7.0%

 Surrender Period:

– 9-10 Year…...………..…48.7%

– 12-14 Year……….……..…14.0%

– 15 Year ………….……..……….…30.6%

– 19-20 Year……….5.6%

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Indexed UL Sales - 2011

Top Characteristics of 4

th

Quarter Sales

May 30, 2014

Source: AnnuitySpec’s Sales & Market Report 4th Quarter 2011

 46 Carriers Offering Product

 Crediting Method

– Annual Point-to-Point ……… 70.4%

 Index

– S&P 500…………..………..…..…..86.4%

– Rainbow/Multi-Index………4.6%

– Other (including Fixed)……….…....9.0%

 Surrender Period:

– 9-10 Year…...………..…37.0%

– 12-14 Year..…….……..……….…9.8%

– 15-Year……….……..…26.7%

– 19-20 Year………23.0%

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Indexed UL Sales - 2008

Top Characteristics of 4

th

Quarter Sales

May 30, 2014

Source: AnnuitySpec’s Sales & Market Report 4th Quarter 2008

 35 Carriers Offering Product

 Crediting Method

– Annual Point-to-Point ……… 64.5%

 Index

– S&P 500…………..………..…..…..The norm

– Rainbow/Multi-Index………6 carriers offering

– Non-S&P (including international)…....8 carriers offering

 Surrender Period:

– 9-10 Year…...………..…50.1%

– 12-14 Year……….……..…1.8%

– 15 Year ………….……..……….…27.8%

– 19-20 Year………15.6%

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Leaning on IUL

 Traditional current assumption UL difficulty illustrating

– Low cost death benefit

– Retirement income

 Indexed UL becoming a “go to” UL product

– Attractive illustrated rates for non-guaranteed crediting

 Annual pt to pt with cap remains most prevalent method

 Sometimes offer methods merely to boost illustrated rate

– 2-yr pt to pt, even though seldom chosen by policyholders

 Leaning on IUL - can one product do it all well?

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Product Features - IUL

 Secondary Guarantees

 GLWB

 Indices and Crediting Strategies

 LTC Combo and Chronic Illness

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IUL Considerations

 Choosing equity growth rates for pricing and illustration testing

 AG 36

 Offering guarantees, incorporating AG38

 Setting cap and participation rates

 Illustration issues – proposed actuarial guideline

 Variable rate loans

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Indexed Modeling Complexities

 Option pricing models

– Volatility surfaces

– Data less readily available than some

– Some options do not have closed form

 The need to model asset portfolio in pricing as part of assessing

interest rate risk

 Solvers to model rate setting; management action levers

– Caps

– Participation rates

– Spreads

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Indexed Modeling Complexities (Continued)

 Multiple crediting strategies

 Multiple buckets

– At least 12 per crediting strategy for IUL

 In-force Modeling Complexities

– Mapping of Buckets

– Global Hedges versus Liability cell specific hedges

– Others?

 Stochastic Pricing

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Indexed UL Pricing Case Study

 Started with traditional fixed UL

– Endowment premium at 3.25% credited interest

– 10 year per unit load to get starting IRR

 Switched to indexed product

– First with UL premium

– Recalculated premium with same mechanics, 6.5% indexed growth

– Recalculated premium again, 6.5% but 50% of prior per unit load

 Ignored AG36 for this example

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Indexed UL Pricing Case Study

May 30, 2014

PV at 10% PV at 10% PV at 10%

Product Fixed UL Indexed UL Indexed UL

Credit/Growth 3.25% 3.25% 6.50%

Premium UL Endow UL Endow UL Endow

Hedge Ratio Original 100% 100% IRR 11.5% 11.7% 19.1% InvIncome $12,684 $12,230 $15,870 Option Purchase $0 ($11,123) ($13,923) Option Maturity $0 $10,254 $25,264 Gen Int Credits $10,610 $280 $274 Indexed Credits $0 $9,374 $23,277 Interest Margin $2,074 $2,892 $5,274 Expense Loads $16,623 $16,616 $16,655 Expenses/Commissions $21,914 $21,914 $21,914 Expense Margin ($5,291) ($5,298) ($5,259) Funds released on Surrender $16,843 $16,606 $20,872 Surrender benefits $14,714 $14,681 $18,254 Surrender Margin $2,129 $1,925 $2,618 COIs $7,180 $7,198 $6,756 Funds released on Death $989 $973 $1,781 Death benefits $5,357 $5,357 $5,711 Mortality Margin $2,812 $2,814 $2,827 AV/Res Diff/Int on TS ($2,585) ($2,034) ($2,443) Sum $4,309 $4,364 $7,894

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Indexed UL Pricing Case Study

May 30, 2014

PV at 10% PV at 10% PV at 10%

Product Indexed UL Indexed UL Indexed UL

Credit/Growth 6.50% 6.50% 6.50%

Premium UL Endow First IUL Endow Revised IUL Endow

Hedge Ratio 100% Original 50% of Original

IRR 19.1% 39.6% 17.4% InvIncome $15,870 $7,989 $7,344 Option Purchase ($13,923) ($5,447) ($6,157) Option Maturity $25,264 $9,883 $11,171 Gen Int Credits $274 $280 $203 Indexed Credits $23,277 $9,006 $10,579 Interest Margin $5,274 $3,779 $2,298 Expense Loads $16,655 $14,689 $8,712 Expenses/Commissions $21,914 $14,203 $9,702 Expense Margin ($5,259) $486 ($4,394) Funds released on Surrender $20,872 $8,610 $9,727 Surrender benefits $18,254 $6,783 $7,679 Surrender Margin $2,618 $1,827 $2,047 COIs $6,756 $7,587 $7,545 Funds released on Death $1,781 $647 $678 Death benefits $5,711 $5,358 $5,357 Mortality Margin $2,827 $2,876 $2,866 AV/Res Diff/Int on TS ($2,443) 221 ($1,392) Sum $7,894 $8,746 $4,206