Equity-Based Investment
   Guarantee Conference

   Managing Variable Annuity
   Guaranteed Minimum Death &
   Living Bene...
Disclaimer

This material is for information purposes only. There is no assurance that a transaction will be entered into ...
Lessons learned From
  Current Markets




                       GMxB Solutions   3
Lessons Learned from Recent Market Performance
                                                          Volatile Markets
...
Lessons Learned from Recent Market Performance
                    Markets in Fear




* Source WSJ.com article “What's Be...
Hedging programs P/L:
                    Dynamic hedging program
                            Dynamic Hedge Performance Wi...
Example: Delta Hedging Annual Ratchet GMxB
            Delta hedging of an annual ratchet GMxB (i.e. look-back options), e...
Delta Hedging: Impact of Recent Market Movements
         Delta hedging a 5% Roll-Up Guarantee with daily rebalancing
    ...
Delta Hedging: Impact of Recent Market Movements
HOWEVER, the impact of recent market movements on a 5Y delta hedge of a 5...
We are now in high volatility environment…
                                                                               ...
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
Managing Variable Annuity GMxB Guarantees
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Managing Variable Annuity GMxB Guarantees

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2008 Equity Based Insurance Guarantees Conference

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Managing Variable Annuity GMxB Guarantees

  1. 1. Equity-Based Investment Guarantee Conference Managing Variable Annuity Guaranteed Minimum Death & Living Benefits 8:30 am – 10:00 am October 28th, 2008 Boston, MA, USA Frank Zhang, CFA, FRM, FSA, MSCF, PRM Director, Equity Derivatives Tel: 1-212-278-6273 FRANK.ZHANG@SGCIB.COM 1987-2007 Equity Derivatives House of the Year “Modern Great” in Equity Derivatives
  2. 2. Disclaimer This material is for information purposes only. There is no assurance that a transaction will be entered into on any indicative terms. SG Americas Securities, LLC (“SGAS”) believes the information in this document is reliable but makes no representation or warranty as to whether the information is current, accurate or complete. SGAS is under no obligation to update, modify or amend this communication or to otherwise notify you that any matter contained herein changes or subsequently becomes inaccurate. SGAS and its affiliates expressly disclaim all responsibility for any use of or reliance upon this document. This document is provided solely for informational purposes only and may not be construed as an offer to buy or sell, or a solicitation of an offer to buy or sell any financial instrument or to engage in any particular trading strategy or as an official confirmation of terms. Investors must make their own investment decisions using their own independent advisors while considering their own financial situation and investment objectives. SGAS and its affiliates do not act as a financial adviser or as a fiduciary in respect of any transaction unless such entity expressly agrees so in writing. This document may not be relied upon as investment, accounting, legal, regulatory or tax advice or an investment recommendation. You should refer to any offering document relating to any financial instrument which includes important information, including related risk factors. Financial instruments of the type described herein may involve a high degree of risk and their value may be highly volatile. Such risks include, without limitation, risk of adverse or unanticipated market developments, risk of counterparty or issuer default, risk of adverse events involving any underlying reference obligation or entity and risk of illiquidity. In some financial instruments, counterparties may lose their entire investment or incur an unlimited loss. This brief statement does not disclose all the risks and other significant aspects in connection with transactions of the type described in the materials. You are urged to consider carefully whether any products discussed herein are appropriate for you or any of your clients given your or their objectives, experience, financial and operational resources and other relevant circumstances. This document may not be reproduced, distributed or published by any person for any person without the prior written consent of SGAS © 2008 Société Générale, SG Americas Securities, LLC and their affiliates. SG CIB is the Corporate and Investment Banking arm of SG. Certain services described herein are provided by SGAS, a US registered broker-dealer, member of FINRA and SIPC, and a wholly owned subsidiary of Société Générale. Services provided outside the US may be provided by affiliates of SGAS.
  3. 3. Lessons learned From Current Markets GMxB Solutions 3
  4. 4. Lessons Learned from Recent Market Performance Volatile Markets History of 10-year swap rates, S&P 500 index, 10-year implied volatility 30% 1,800 1,600 25% 1,400 20% 1,200 1,000 15% SP500 10Y Implied Vol 800 10Y USD Swap Rate SP500 10% 600 400 5% 200 0% 0 12/31/99 12/31/00 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 3/31/00 6/30/00 9/30/00 3/31/01 6/30/01 9/30/01 3/31/02 6/30/02 9/30/02 3/31/03 6/30/03 9/30/03 3/31/04 6/30/04 9/30/04 3/31/05 6/30/05 9/30/05 3/31/06 6/30/06 9/30/06 3/31/07 6/30/07 9/30/07 3/31/08 6/30/08 9/30/08 Choppy markets, high implied vol, and low interest rates have been challenging for VA hedging programs GMxB Solutions 4
  5. 5. Lessons Learned from Recent Market Performance Markets in Fear * Source WSJ.com article “What's Behind the Surge in the VIX” 10/23/08 GMxB Solutions 5
  6. 6. Hedging programs P/L: Dynamic hedging program Dynamic Hedge Performance With Decrements 10,000,000 160,000 140,000 8,000,000 120,000 6,000,000 100,000 4,000,000 co n a e A c u t V lu 80,000 2,000,000 60,000 - 40,000 (2,000,000) 20,000 (4,000,000) - 0 100 200 300 400 500 Option Value Cum Futures G/(L) + PV of Option Premium Account Value Delta/Rho dynamic hedging: In general bleeds money over time through buy high and sell low The cost of hedge bleeding is equivalent to the up front option premium But with less certainty even if the realized vol is the same as the implied vol, due to path dependency. Even if no up front premium is spent initially The amount can be implicitly assumed borrowed from the collection of future fees The amount is borrowed and has to be paid back GMxB Solutions 6
  7. 7. Example: Delta Hedging Annual Ratchet GMxB Delta hedging of an annual ratchet GMxB (i.e. look-back options), especially under real-world conditions, is more costly and difficult than hedging vanilla puts P/L Dispersion In Hedging Simulations 35% 30% 25% frequency 20% Look-back Put Vanilla Put 15% 10% 5% 0% -20% -10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% More P/L (% of Initial Value) GMxB Solutions 7
  8. 8. Delta Hedging: Impact of Recent Market Movements Delta hedging a 5% Roll-Up Guarantee with daily rebalancing proved a profitable strategy in 2005 and 2006 PnL 2005 0.30% 108.00% 106.00% 0.20% 104.00% 102.00% 0.10% -> Delta hedging 100.00% strategies were SP500 PnL 0.00% 98.00% 17/01/05 23/05/05 18/07/05 21/11/05 03/01/05 31/01/05 14/02/05 28/02/05 14/03/05 28/03/05 11/04/05 25/04/05 09/05/05 06/06/05 20/06/05 04/07/05 01/08/05 15/08/05 29/08/05 12/09/05 26/09/05 10/10/05 24/10/05 07/11/05 05/12/05 19/12/05 profitable in 2005 96.00% -0.10% 94.00% 92.00% -0.20% Daily PnL 90.00% Index Cumulative PnL -0.30% 88.00% Date PnL 2006 0.30% 115.00% 0.25% 110.00% 0.20% 105.00% 0.15% -> Delta hedging 0.10% strategies were 100.00% SP500 PnL 0.05% profitable in 2006 95.00% 0.00% 17/01/06 31/01/06 14/02/06 28/03/06 11/04/06 25/04/06 23/05/06 06/06/06 20/06/06 01/08/06 15/08/06 29/08/06 26/09/06 10/10/06 24/10/06 05/12/06 19/12/06 03/01/06 28/02/06 14/03/06 09/05/06 04/07/06 18/07/06 12/09/06 07/11/06 21/11/06 -0.05% 90.00% -0.10% Daily PnL 85.00% -0.15% Index Cumulative PnL -0.20% 80.00% GMxB Solutions 8 Date
  9. 9. Delta Hedging: Impact of Recent Market Movements HOWEVER, the impact of recent market movements on a 5Y delta hedge of a 5% Roll-Up Guarantee with daily rebalancing WAS VERY NEGATIVE – realized volatility proved higher than anticipated leading to significant losses starting August 2007 PnL 2007 0.60% 115.00% 0.40% 110.00% 0.20% 105.00% 0.00% -> Delta hedging 17/01/07 31/01/07 11/04/07 25/04/07 04/07/07 18/07/07 26/09/07 03/01/07 14/02/07 28/02/07 14/03/07 28/03/07 09/05/07 23/05/07 06/06/07 20/06/07 01/08/07 15/08/07 29/08/07 12/09/07 10/10/07 24/10/07 07/11/07 21/11/07 05/12/07 19/12/07 100.00% SP500 PnL -0.20% strategies were losing 95.00% -0.40% money in H2 2007 90.00% -0.60% Daily PnL 85.00% Index -0.80% Cumulative PnL -1.00% 80.00% Date PnL 2008 0.10% 105.00% 0.00% -> Delta hedging 100.00% 8 8 08 08 08 08 16 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 /0 /0 1/ 1/ 1/ 1/ 1/ 2/ 2/ 2/ 2/ 2/ 2/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 2/ 2/ 2/ 2/ 2/ 1 1 -0.10% /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 strategies have now 15 02 04 06 08 10 12 14 18 20 22 24 26 28 30 01 03 05 07 09 11 13 17 19 21 95.00% in Q1 2008 already -0.20% SP500 PnL lost almost as much -0.30% 90.00% money as in the entire -0.40% 2007… Daily PnL 85.00% -0.50% Index Cumulative PnL -0.60% 80.00% GMxB Solutions 9 Date
  10. 10. We are now in high volatility environment… High Volatility cycle Low Volatility cycle 35.00% 1600 SP500 3M volatility 1400 30.00% SP500 12M volatility SP5000 value 1200 25.00% 1000 20.00% 800 15.00% 600 10.00% 400 5.00% 200 0.00% 0 1/1/1990 4/1/1990 7/1/1990 1/1/1991 4/1/1991 7/1/1991 1/1/1992 4/1/1992 7/1/1992 1/1/1993 4/1/1993 7/1/1993 1/1/1994 4/1/1994 7/1/1994 1/1/1995 4/1/1995 7/1/1995 1/1/1996 4/1/1996 7/1/1996 1/1/1997 4/1/1997 7/1/1997 1/1/1998 4/1/1998 7/1/1998 1/1/1999 4/1/1999 7/1/1999 1/1/2000 10/1/1990 10/1/1991 10/1/1995 10/1/1996 10/1/1997 10/1/1992 10/1/1993 10/1/1994 10/1/1998 10/1/1999 Towards a higher Volatility SP500 3M volatility 35.00% 1800 environment? SP500 12M volatility 1600 30.00% SP5000 value 1400 25.00% 1200 -> Delta hedging 20.00% 1000 strategies are 800 15.00% now losing High Volatility 600 10.00% money 400 cycle with 5.00% 200 declining 0.00% 0 1/3/2000 5/3/2000 9/3/2000 1/3/2001 5/3/2001 9/3/2002 1/3/2003 5/3/2003 9/3/2003 1/3/2004 9/3/2004 1/3/2005 5/3/2005 9/3/2005 1/3/2007 5/3/2007 9/3/2007 1/3/2008 9/3/2001 1/3/2002 5/3/2002 5/3/2004 1/3/2006 5/3/2006 9/3/2006 markets (unhedged insurers lost money) NB: in 1987, the 3 month volatility reached 70% … Low Volatility cycle when insurers started delta hedging GMxB Solutions 10

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