Frings SOA Annuity Risk Strategies Using Reinsurance 2013 Oct 20

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Annuity reinsurance is useful for companies to manage annuity risk. This presentation I created for the Society of Actuaries 2013 Annual Meeting in San Diego. I discuss motivtion, opportunites and strategies for annuity reinsurance. I present a numerical case study on coinsurance and longveity swaps to mitiage longevity risk.

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Frings SOA Annuity Risk Strategies Using Reinsurance 2013 Oct 20

  1. 1. 2013 SOA Annual Meeting – San Diego PD 60 - Annuity Risk Strategies Annuity Reinsurance Michael Frings, FSA, MAAA Vice-President and Senior Actuary, Global Financial Solutions RGA Reinsurance Company 2013 SOA Annual Meeting - PD 60 - Annuity Risk Strategies | October 20, 2013
  2. 2. Table of Contents 2  Motivations for Annuity Reinsurance  Opportunities for Annuity Reinsurance  Annuity Reinsurance Strategies  Longevity Swap Case Study  Summary
  3. 3. Motivations for Annuity Reinsurance 3
  4. 4.  Premiums/Deposits  Flexible  Single  Crediting Approach  Fixed  Declared Rate  Indexed  Variable/Unit-linked  Payout Period  Deferred  Immediate  Extra Benefits  GMDB, GMIB, GMAB, GLWB, etc. Features & Motivations Key annuity features… 4 Key reinsurance motivations…  Support new business  VIF monetization  Release capital  Reduce risk
  5. 5.  Movement/Actions…  in financial markets,  in competitive landscape,  by annuity owners, and/or  by agents/representatives  Aided by…  Product design weak points  Ins co management decisions  Result in Missed Expectations of Ins Co Financial Performance  Under Statutory, US GAAP, IFRS, Economic, Management reporting Annuity Risks in General Terms Manifest in a Cascading Effect of… 5 “Isn’t It Just an Annuity…How Risky Can Those Be?...”
  6. 6. Risks in Specific Terms To Name a Few… 6  Interest Margin/Spread  Asset Impairment/Default  Equity  Hedging  Longevity  Expense  Mortality  Taxation  Accounting Volatility  Valuable, throw-away options  such as additional deposits  Liquidity/’Run-on-bank’  Competition ‘Frenzy’  Social Media  Awake the Sleeping Annuity Owner  Sophisticated Buyers  Reputation  Re-pricing Limitations  Administrative Systems  Valuation Systems  Projection/Pricing Systems  Compliance/Fraud  Insurance Company Management  Regulatory Actions  Rating Agency Actions Magnified by mis-estimation, mis-prioritzation of risks
  7. 7. Opportunities for Annuity Reinsurance 7
  8. 8.  Measuring Risks  Differences in incidence/frequency.  Differences in amounts  Differences in length  Reporting Risks  Financial Accounting: US GAAP, IFRS, Local Regulatory (e.g. US Stat)  Management Accounting: Operating vs Non-operating earnings  Pricing Risks  Metrics vary: MCEV, ROE, ROI, ROA, Cost of Funds, Surplus Contribution, etc.  Regulating Risks  Local regulatory requirements vary across jurisdictions  Rating Risks  Rating agency ratings are important to many—but not all  Capital requirements diverge: S&P, Moody’s, Fitch, AM Best, etc. Opportunities Abound! Often found when a ‘difference in view’ appears in… 8
  9. 9. Annuity Reinsurance Strategies 9
  10. 10.  Location, location, location…  Onshore, offshore  Captive  Complex mix including SPVs, etc.  Traditional Forms  Coinsurance—either with/without funds withheld  Modified coinsurance  Combination of above  Less-Traditional Forms  Non-insurance, financial guarantees  Swaps—either as insurance or derivatives Annuity Reinsurance Strategies 10 Next, a case study in longevity swaps to manage annuity risks…
  11. 11.  Client  A large corporation in the US  Generous defined benefit program upon retirement  Plan closed: all participants in payout period  Risks  Asset default/impairment  Re-investment  Longevity  Characteristics  Mix 33%/67% M/F  Ages 70/67 M/F  $2,000 monthly annuity benefit  20,000 starting lives  1% annual benefit escalation Longevity Swap Case Study Assume the following… 11 $- $5 $10 $15 $20 $25 $30 $35 $40 $45 AmountsPaid(inmilions) Years Gross Benefit Payments: Expected Expected Benefits
  12. 12.  Coinsurance  Cede all risks  Pay upfront consideration  Markets: Who offers, Who buys  Characteristics  Pros/Cons Longevity Swap Case Study Two key ways to manage the longevity risk… 12  Longevity Swap  Cede longevity…keep investment risk  No upfront payments—net settle  Market: Who offers, Who buys  Characteristics  Pros/Cons Assumptions: 5% loading of expected benefits Ceding co discount rate 8% Reinsurer discount rate 6% $- $0.5 $1.0 $1.5 $2.0 $2.5 $- $5 $10 $15 $20 $25 $30 $35 $40 $45 2014 2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 NetAmounts(inmillions) GrossAmounts(inmilions) Years Cash Flows: Expected Expected Benefits (floating leg) Reinsurance Premium (fixed leg) Net Payments to Reinsurer $368 $460 $93 $- $100 $200 $300 $400 $500 Millions Coinsurance: Initial Values Ceding Company Liability Coinsurance Initial Consideration Net Payment Over Liability Held A sizeable out of pocket expense Payment deferred —upside potential
  13. 13. Longevity Swap Case Study Application of a longevity swap… 13 $- $5 $10 $15 $20 $25 $30 $35 $40 $45 2014 2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 AmountsPaid(inmilions) Years Gross Longevity Swap Cash Flows: Stressed Expected Benefits Benefits at 90% qx Benefits at 110% qx Benefits at 1.5% improvement Benefits at -1.5% improvement Benefits at 90% qx, 1.5% improvement Benefits at 110% qx, -1.5% improvement Reinsurance Premium  Benefits typically settle monthly  Benefits are especially sensitive to mortality improvement assumption  Collateral as a negotiated item $(8) $(6) $(4) $(2) $- $2 $4 AmountsPaid(inmilions) Years Net Longevity Swap Cash Flows: Selected Stressed Expected Benefits at 90% qx Benefits at 110% qx Benefits at 1.5% improvement Benefits at 90% qx, 1.5% improvement
  14. 14. Longevity Swap Case Study Case study present values… 14 # Ceding Company Present Values @ 8% Before Reinsurance After Swap Benefits at 90% qx Benefits at 1.5% improvement Benefits at 90% qx, 1.5% improvement 1 PV(expected benefit payments) $368 2 PV(actual benefit payments) $368 $368 $376 $382 $391 3 PV(reinsurance premium) $386 4 PV(Net payments to reinsurer) $18 $10 $4 $(5) 5 Ratio of 3 to 2 5.00% 2.22% -0.24% -2.90%  Key pricing parameters:  Base mortality table, future mortality improvement, premium loading, collateral  Arriving at a ‘meeting of the minds’ on terms is not easy  Longevity swaps a very good way to manage block longevity risk Takeaways…
  15. 15. Summary 15
  16. 16.  Motivation  Many motivations  Opportunities  May appear when there is a difference in view  Strategies  Both traditional & non-traditional approaches abound  Many variations not discussed here  Case Study: Longevity  Longevity swaps offer an efficient way to mitigate future risks of annuitants living beyond expectations  A good fit for some opportunities What We Covered Annuity Reinsurance Applications… 16
  17. 17. Thank you for your attention. 17

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