Deep dive on FIA (Fixed index annuity) statutory reserving

1. © Oliver Wyman
Indexed Product Valuation
Society of Actuaries – Valuation Actuary Symposium
Washington, D.C. – August 28, 2018
Nicholas Carbo, FSA, MAAA

2. 1© Oliver Wyman
Agenda
1 Background on fixed indexed annuities (FIA)
2 FIA statutory reserving
3 Base FIA walkthrough
4 FIA GLWB walkthrough
5 Reserve strain mitigants

3. 2© Oliver Wyman
Background on base FIAs
FIAs are fixed deferred annuities with indexed-linked crediting
Fixed indexed annuitiesFixed annuities
1
Reserve basis
Interest
guarantees
Credited
interest
Investments
2
3
4
Assets backing reserves are invested
mostly in fixed income general account
Interest is credited based on rates
specified by the insurance company
Crediting rate is guaranteed for one or
multiple years (MYGA)
Actuarial Guideline 33
Assets are invested in both fixed income
and call options
Interest is credited based on the return
on an index, subject to provisions
(e.g., cap)
Interest not guaranteed; crediting
features subject to renewal minimums
Actuarial Guideline 33 and Actuarial
Guideline 35

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Background on FIA GLWBs
GLWB features (benefit base, rollup, etc.) create a guaranteed income stream
Key rider product features
1 Benefit base
Shadow account value which
determines the basis for GLWB
payments
2 Roll-up
The roll-up is the method by which
the benefit base increases
3 Roll-up period
The period of time the roll-up
occurs for
4 Payout factors
The percent of the benefit base
that is paid out as annual income
5 Rider fees
The fee assessed against the
primary account value for the rider
GLWBs preserve the liquidity of a deferred annuity with the income guarantee of an income annuity
Rider mechanics
Year Benefit base Account value Rider fee Payout factor PW benefit paid
0 $ 100,000 $ 100,000 $ - 4.50% $ -
1 107,000 100,980 1,000 4.50% -
2 114,000 101,908 1,070 4.50% -
3 121,000 102,784 1,140 4.50% -
4 128,000 103,605 1,210 4.50% -
5 135,000 97,487 1,280 5.00% 6,750
6 135,000 91,174 1,350 5.00% 6,750
7 135,000 84,736 1,350 5.00% 6,750
8 135,000 78,168 1,350 5.00% 6,750
9 135,000 71,470 1,350 5.00% 6,750
10 135,000 64,637 1,350 5.00% 6,750
11 135,000 57,668 1,350 5.00% 6,750
12 135,000 50,559 1,350 5.00% 6,750
13 135,000 43,309 1,350 5.00% 6,750
14 135,000 35,913 1,350 5.00% 6,750
15 135,000 28,369 1,350 5.00% 6,750
16 135,000 20,674 1,350 5.00% 6,750
17 135,000 12,826 1,350 5.00% 6,750
18 135,000 4,820 1,350 5.00% 6,750
19 135,000 - - 5.00% 6,750

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FIA statutory reserving
FIA reserves are governed by two actuarial guidelines which clarify the application of
CARVM
Actuarial Guideline
33 defines the
requirements for
fixed annuity
reserving.
The calculation of reserves requires the reserve
to be at least the maximum PV of guaranteed
future benefit streams.
• Specified valuation rates
• Specified mortality and mortality improvement
• Guaranteed features are projected forward
AG 35
Actuarial Guideline
35 defines the
projection of
interest crediting
for index annuity
contracts in the
AG33 calculation.
AG35 is defines the projection of guaranteed
credited interest for index accounts. Options
include:
• Hedged as required and not hedged as required
options
• Various methods to project the projected
guaranteed credited rate
AG 33

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Base FIA walkthrough
The two key benefit streams for the base FIA are the surrender and partial
withdrawal paths
Surrender path
• Projection of guaranteed surrender value at the
beginning of each contract year
Partial withdrawal path
• Projection of guaranteed surrender value at the end of the
surrender charge period assuming an optimal utilization of the
free partial withdrawal feature
Year Account
value
Cash value PV (CSV)
0 $100,000 $92,800 $92,800
1 101,000 94,637 91,437
2 102,010 96,501 90,085
3 103,030 98,394 88,746
4 104,060 100,314 87,418
5 105,101 105,101 88,492
Year Account
value
Cash value Partial
withdrawal
Surrender
benefit
PV
(benefits)
0 $100,000 $92,800 $10,000 $10,000
1 90,900 85,173 9,090 8,783
2 82,628 78,166 8,263 7,713
3 75,109 71,729 7,511 6,774
4 68,274 65,816 6,827 5,950
5 62,061 62,061 $62,061 52,254
Total PW reserve $91,474
Reserve = Max(cash surrender value, PV of surrender paths, PV of FPW during SC followed by surrender)

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Base FIA walkthrough (continued)
Indexed credits both increase the account value and statutory reserves, but a
mismatch can arise because of surrender charges
Time 0 1
Revenue
Premium $ 100,000
Investment income - $ 4,475
Hedge purchase (1,500) -
Hedge maturity - 3,000
Total $ 98,500 $ 7,475
Expenses
Commission $ 7,000
Benefits paid - -
D Res SC 91,000 900
D Res index credits - 2,757
Total $ 98,000 $ 3,657
Pre-tax/Pre-cap $ 500 $ 3,818
Hedging the account value creates statutory P&L volatility
Due to surrender charges, the reserve
change is smaller than the hedge
payoff. This creates additional income
in up markets and generates losses in
down markets.
Assumes hedging of 100% of account
value (Index credit is $3,000)
The reserve change is lower than
the account value credit due to
surrender charges

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FIA GLWB walkthrough
AG 33 requires evaluation of all possible income streams under the GLWB rider
Year Attained
age
Benefit
base
Payout
factor
Guaranteed
income
0 60 $100,000 4.00% $4,000
1 61 107,000 4.00% 4,280
2 62 114,000 4.00% 4,560
3 63 121,000 4.00% 4,840
4 64 128,000 4.00% 5,120
5 65 135,000 5.00% 6,750
6 66 142,000 5.00% 7,100
7 67 149,000 5.00% 7,450
8 68 156,000 5.00% 7,800
9 69 163,000 5.00% 8,150
10 70 170,000 5.50% 9,350
Key factors in reserving
• Requires holding the greatest present value of
integrated benefit streams
• Every possible GLWB path should be
considered with zero surrenders along the way
• Prescribed valuation rates vary by benefit
stream and features
Key risks
• Correct coding of logic and features
• Associating the “right” valuation rate to each
benefit stream
• Data considerations (MGSV, withdrawal
tracking, joint policies)
Possible income streams

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FIA GLWB walkthrough (continued)
GLWB reserves follow a pattern consistent with a deferred income annuity
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
0 5 10 15 20 25 30 35 40
Duration
Account value GLWB reserve CSV
The reserve
increases above the
account value
before income starts
Hedging impact
• The reserve is mostly driven by the income
benefit (similar to a deferred income annuity)
and only minimally by indexed credits
Rider charges impact
• Rider charges do not cause a dollar-for-dollar
reduction in reserves
Illustrative account value and reserves

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Reserve strain mitigants
VM-22 will possibly decrease the strain associated with GLWBs
Financial reinsurance
• Increases financial leverage
• Increase in pricing IRR
VM - 22
• Principles-based
• Potential for lower reserves
AG - 43
• Principles-based
• Potential changes to VM-21 & AG 43
Valuation rates
• Some states have offered relief
i
Indexed-linked income can alleviate the strain associated with GLWBs

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AG 33 financial reinsurance
Financial reinsurance can reduce GLWB reserve strain
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
0 5 10 15 20 25 30 35 40
DurationAccount value GLWB reserve
CSV Economic reserves
Illustrative account value and reserves Financial reinsurance
• There are opportunities to structure financial
reinsurance to obtain reserve credit for non-
economic reserves
Financial reinsurance considerations
• Definition of economic reserve
• Risk transfer
• Recapture provisions
• Risk charge
Reinsuring excess reserves can result
in an increased IRR for the writing company,
but comes with a fee to pay a reinsurer

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Key takeaways
1 FIA statutory reserves are not aligned with hedge economics
2
Carriers are subject to regulatory risk (e.g., indirect impact of VA NAIC Capital Reform on
carriers using AG 43)
3 Financial reinsurance is increasingly used to mitigate GLWB strain

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Questions