Hedging Variable Annuity Guarantees
August 7, 2010
Jeff Coutts
Vice President, Head of Profitability, Risk &
Implementation Management
Fort Wayne, IN
Valuation
Management Reporting
Defined Contribution
Product Management
Radnor & PHL, PA
Corporate Center
Equity Risk Management
Omaha, NE
Group Protection
Hartford, CT
Life/Annuity Product
Management
Executive Benefits
Product Management
Greensboro, NC
Life/Annuity Product
Management
Product Risk and Liability
Valuation
Lincoln’s Actuarial Presence
¾
150 actuaries
¾
60 students
Agenda
¾
Hedge program basics
¾
Performance throughout crisis
Hedge Program Basics
Variable Annuity Overview
¾
Variable annuity industry sales of $125B in 2009*
¾
Base contract provides tax preferred investment vehicle and
annuitization option
¾
Majority of sales include additional benefit riders:
Guaranteed Minimum Death Benefits (GMDBs)
Guaranteed Living Benefits (GLBs)
-
Guaranteed Minimum Withdrawal Benefit (GMWB)
-
Guaranteed Minimum Income Benefit (GIB)
-
Guaranteed Minimum Accumulation Benefit (GMAB)
¾
GLBs and GMDBs guarantee certain performance or level of
¾
Historically only hedge guarantees, not the base
contract
¾
Liability changes as market inputs change
¾
Hedge programs limit financial impact of higher
reserves/claims due to declining market conditions
Hedge Program Basics
Effectiveness
Cost
No Protection
Static Hedging
Delta Hedging
3 Greek Hedging
Full Reinsurance
Hedge Program Basics
VA Risk Management Spectrum
Hedge Program Basics
“3 Greek” Hedging
¾
“Greeks” measure sensitivity of liability to a given market condition
¾
Lincoln actively manages impact of 3 market measures
Rho
Vega
Delta
Market Measure
Interest rate Decrease
Volatility Increase
Market Drop
Liability Impact
Market Condition
-√
-Interest Rate futures
-√
-Interest Rate Swaps
-√
Equity Futures
√
-Variance Swaps
√
√
√
Put Options
Vega
Rho
Delta
Instrument
Greek Exposure
¾
Derivative instruments are purchased to match the liability
exposure to each of the Greeks
Hedge Program Basics
¾
Financial crisis put unprecedented stress on hedge
programs:
Huge daily market swings
Extreme volatility = Higher Cost
Interaction of market forces
¾
So how did we do?
Performance Throughout Crisis
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Mar
2008
Jun
2008
Sep
2008
Dec
2008
Mar
2009
Jun
2009
Sep
2009
Dec
2009
Hedge Target
Hedge Asset
Average S&P 500
¾
Not Perfect, but overall we did quite well
¾
Hedge assets accumulated to offset our growing liability
Average S&P 500
Hedge Target/Hedge Ass
e
ts (in bil
li
o
ns)
Performance Throughout Crisis
(3,000) (2,000) (1,000) -1,000 2,000 3,000 1q08 2q08 3q08 4q08 1q09 2q09 3q09 4q09 (i n millio n s )
GLB Hedge Breakage GLB Change in Reserves
Performance Throughout Crisis
¾
Reducing Breakage
¾
Capital Market Conditions/Hedging Cost
¾
Accounting Considerations
¾
Impact/Concerns
Largest source of breakage
Only explicitly hedge first order market movements
Difficult to capture the interdependency of the Greeks
¾
Preventative Actions
Exploring different hedge instruments
Consider macro hedge
Current Issues
¾
Impact/Concerns
Withdrawal and investment activity not tracked in
real time
May cause over or underhedged position
¾
Preventative Actions
Product design- restrictions on policyholder
behavior
Building experience to improve tracking and
forecasting
Current Issues
¾
Impact/Concerns
Has produced favorable breakage due to fund
outperformance
Derivative assets based on indices that try to
mimic underlying policyholder investments
¾
Preventative Actions
Continue improving fund mapping
Carefully evaluate funds in VA lineup
Current Issues
Current Issues
Capital Market Conditions
10 Year @ the Money S&P Put Cost
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00%
Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10
% o f P re m iu m
