This document discusses pricing and reinsurance strategies for fixed indexed annuities (FIAs). It begins with an overview of the FIA market opportunity and struggles with pricing FIAs. It then presents a numerical example of a sample FIA, showing the financial results under US statutory and US GAAP accounting standards. Various methods to improve returns are discussed, including the use of reinsurance. Reinsurance is explored as a tool to improve returns by positively impacting elements of the DuPont analysis like operating margins, asset leverage, and tax rates. The document concludes that reinsurance can enhance both statutory and GAAP financial results for FIAs.

1. Pricing and Reinsurance Strategies
for Fixed Indexed Annuities
Michael Frings FSA, CFA, MAAA
May 17, 2016
Vice President and Senior Actuary, Pricing
Global Financial Solutions
RGA Reinsurance Company
Presentation for Session 53 Panel Discussion: Indexed Annuity Pricing Considerations
at the SOA Life and Annuity Symposium in Nashville, Tennessee

2. 2
Aims
 Objectives of this Presentation
1. Better understand opportunities & difficulties with pricing FIAs
2. Observe how reinsurance can address some of these difficulties
 Focus of this Presentation
1. Fixed indexed annuities and GLWB riders
2. Financial results under US Stat and US GAAP accounting standards
3. Capital models under RBC
 Extrapolation to other accounting and capital regimes is outside the scope of this presentation
To evaluate pricing of Fixed Indexed Annuities (FIAs) and uses of Reinsurance

3. 3
Topics
 Market Opportunity
 Struggles with Pricing
 Introduce a Numerical Example
 Methods to Improve Returns
• Introducing a 6-factor DuPont Analysis
 Reinsurance: Uses and Considerations
• Applied to Numerical Example
 Conclusions
Related to FIAs and GLWB riders…

4. 4
Market Opportunity
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60.0
80.0
100.0
120.0
2007 2008 2009 2010 2011 2012 2013 2014 2015
inbillion$
Deferred Income
Structured Settlements
SPIA
MVA
FIA
Book value
Book value fixed annuity new sales peaked in 2008-2009…now FIAs are the top-sellers
Source: LIMRA Secure Retirement Institute
 Indexed Annuities grew from $25 bn to $55 bn (up 118%) at a 9% CAGR
 Book value annuities peaked at $51 bn and $53 bn in 2008 and 2009, respectively.
In 2015, FIAs were 53% of new fixed annuity sales

5. 5
Market Opportunity
 Declining bond yields can weaken the value proposition of fixed annuities
• For consumers=> lower credited rates, lower accumulated values
• For insurance companies => lower interest margins, stretch to take more asset risk
Source: St. Louis Federal Reserve FRED: Merrill Lynch Corporate Bond Indices
Fixed annuity performance is tied to bond market yields
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8.0
10.0 Dec-1996
Dec-1997
Dec-1998
Dec-1999
Dec-2000
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Dec-2004
Dec-2005
Dec-2006
Dec-2007
Dec-2008
Dec-2009
Dec-2010
Dec-2011
Dec-2012
Dec-2013
Dec-2014
Dec-2015
CorporateBond Yields (%)
ML Corp BBB
ML Corp A

6. 6
Market Opportunity
 Fluctuating capital market volatility makes pricing options, as budgeted,
difficult
Source: Yahoo! Finance
And Indexed features tie FIA performance to the derivatives markets
0.0
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80.0 Jan-1995
Jan-1996
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Jan-2015
Jan-2016
^VIX

7. 7
Market Opportunity
Sources: InvestmentNews; LIMRA Secure Retirement Institute
Guaranteed Living Withdrawal Benefit (GLWB) riders are a key product feature
In 2015, 62% of FIAs were issued with GLWB

8. 8
Struggles with Pricing FIAs
 Low Interest Rate Environment
 Pricing Targets are Hard to Hit
• Are low investment yields lowering expected return targets yet?
 Competitive Market
• Growing sales attracting new entrants…VA writers shifting to FIAs?
• Are we in an arms race for indexing strategies and rider benefits?
 Increasing Complexity of Product Designs and Asset Strategies
Some struggles are familiar to all insurance products…

9. 9
Struggles with Pricing FIAs
 Expenses Difficult to Manage
• Variation by distribution channel: expected and actual experience diverge/vary
 Building Policyholder Behavior Assumptions, static & dynamic, with little data
 Model Metrics: market consistent vs. real world approaches
 GLWB Introduce Material New Longevity Exposure
• Is GLWB closer to a SPIA or a systematic withdrawal benefit or both?
• Mortality improvement: 10yr, 20 yr, longer? Decreases, level or increases?
 Projections of Long-Tail Liabilities Slow Down Model Run Time
• Length of projection makes it difficult to get one’s arms around the product results
• Can better communicate to mgmt with a mix of tabular results (IRR, ROE, ROA, Profit
Margin, EV) and graphical results (earnings & balances)
Setting and managing assumptions…

10. 10
Struggles with Pricing FIAs
 Pricing measures that don’t match how the business is measured and/or how
company management is compensated
 Reconciling economic pricing models that give different results from US Stat
or US GAAP pricing models
 Reconciling pricing results with actual results
• Actual accounting results don’t follow a level IRR pattern
 Uncertain regulatory regimes for companies and product distribution.
• For example, recent DOL rules apply to indexed annuities and are effective in 2017/2018
 Regulatory capital at a premium due to strain created by conservative annuity
reserve (CARVM) calculations
Results WILL vary from pricing…
Increased opportunity for mitigating solutions

11. 11
Numerical Example
 Fixed and Indexed Accounts
 7-year Surrender Charge
 Lifetime GLWB with stacking of indexed credits
 Typical mix of issue ages
 GLWB elections vary by cohort and policy duration
 Lapse rates are dynamically based on rider ITM and competitor rates
versus option budgets
 TAR = Statutory reserves + Target RBC
 Pricing Model Office Projection…Single $100 premium on 1 Jan 2016
Let’s consider a sample FIA with single-digit returns…

12. 12
US Statutory Financial Results
Challenging profit patterns
(15.00)
(10.00)
(5.00)
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2016
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Year
Stat Distributable Earnings
(4.00)
(3.00)
(2.00)
(1.00)
-
1.00
2.00
3.00
4.00
2016
2018
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Year
Stat Book Profits
Pre-Tax Stat Book Profits
After-Tax Stat Book Profits

13. 13
US Statutory Financial Results
US Stat reserves generate significant early Stat surplus strain
 Economic reserve = PV future benefits
 Stat reserves > Economic reserves for first 7 years
• Green shading shows potentially redundant annuity reserves
-
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120.00
Year
Stat Balances
Invested Assets
Stat Reserves
Account value
Economic reserve
Cash Surrender Value
(15.00)
(10.00)
(5.00)
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Year
Stat Balances above CSV
Invested Assets
Stat Reserves
Account value
Economic reserve

14. 14
US Statutory Financial Results
Profit Measure Result
Internal Rate of Return (IRR) 8.19%
Return on Assets (ROA) 0.57%
Profit Margin 4.51%
Embedded Value @ 8% $0.08
Baseline
 IRR on distributable earnings
 ROA is sum (distributable earnings) / sum (statutory reserves)
 Profit Margin is PV (distributable earnings) @ AT earned rate / Premium
 EV is PV (distributable earnings) @ 8%

15. 15
US GAAP Financial Results
Challenging profit patterns
(2.00)
(1.50)
(1.00)
(0.50)
-
0.50
1.00
1.50
2.00
2.50
3.00
2016
2018
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EGP Margins
Interest Margin
Surrender Margin
Expense Margin
Change in SOP 03-1
Total EGPs
(12.00)
(10.00)
(8.00)
(6.00)
(4.00)
(2.00)
-
2.00
4.00
6.00
8.00
2016
2018
2020
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GAAP Distributable Earnings

16. 16
US GAAP Financial Results
Profit Measure Result
Average ROE 6.79%
Return on Assets (ROA) 1.05%
Profit Margin 12.40%
Embedded Value @ 8% -$3.59
Baseline
 Average ROE is undiscounted
 ROA is sum (distributable earnings) / sum (net GAAP liabilities)
 Profit Margin is PV (distributable earnings) @ AT earned rate / Premium
 EV is PV (distributable earnings) @ 8%
How to improve single digit returns?

17. 17
Methods to Improve Returns
 Introducing…the 6-Factor DuPont Analysis
• Take the 5-Factor DuPont Analysis and split out impact of operating earnings from
non-operating earnings as operating earnings are a common business measure
• ROE = [(operating EBIT/sales) x (EBIT/operating EBIT) x (sales / assets) – interest
expense/assets] x (assets / equity) x (1 – tax rate)
• ROE = [(operating profit margin) x (non-operating lift) x (asset use efficiency) – (interest
expense rate)] x (asset leverage) x (tax retention rate)
 The drivers of returns are
• Operating EBIT
• EBIT
• Sales
• Assets
“What you measure and reward is what you are going to get.” -- George Bethune
• Interest expense
• Equity
• Tax rate
Evaluate each component to improve returns

18. 18
Methods to Improve Returns
 Increase Investment Margins => higher operating EBIT
 Reduce Benefits => higher operating EBIT
 Increase GLWB Rider Charges => higher operating EBIT
 Reduce/Defer Expenses & Commissions => higher operating EBIT
 Lower Statutory Reserves & Capital => lower Assets but lower Equity more
• Restructure guarantees in products
• Use curtate CARVM instead of continuous CARVM
• Seek regulatory concessions (e.g., permitted practices, non-disapprovals, etc.)
 Utilize reinsurance => has multiple effects
Dialing up or down each component of the 6-Factor DuPont Analysis…some include…
Consider how you might dial in each factor

19. 19
Why Consider Reinsurance to Improve Returns?
 Create the ‘perfect’ hedge, as reinsurance can mitigate policyholder
behavior while hedging programs cannot
 Reduce earnings volatility
 Sometimes get paid to cede risk…sometimes pay to cede risk
 Can get a 3rd parties’ view of the value of the business written
• Helpful as a reality check on pricing
• Who knows more: direct company or reinsurer?
 Finance redundant regulatory reserves and regulatory capital
 Can improve operating profit margin, non-operating lift, asset leverage and
tax retention rate
A useful tool that can be structured to help achieve product goals

20. 20
Annuity Reinsurance
Source: www.propertycasualty360.com
Market is growing
We see increasing appeal & use of annuity reinsurance

21. 21
Considerations for Reinsurance
 Pass US Statutory risk transfer
• RBC credit, except C4 and C1-o
• Reserves, usually
 May pass or fail US GAAP risk transfer
 Cost efficient
 Execution certainty
Objectives

22. 22
Considerations for Reinsurance
 Effective length of transaction
• Permanent risk transfer. Termination and recapture provisions, if included, must be options
for the ceding company (not the reinsurer) and not mandatory at any point.
 Onshore vs. Offshore
• Balance collateral requirements. Offshore certified reinsurers recently available.
 Captive vs. Non-captive
• Captives effective in consolidating risk and lowering reserve & capital mandates because
different regulatory reserve & capital requirements and asset recognition can apply
 Coinsurance vs. YRT
 Regulatory and Internal Company constraints/approvals
Structural considerations include…

23. 23
Considerations for Reinsurance
 Counterparty exposure
• Collateral: Who is holding the assets? Mod-co v coinsurance? Quality of collateral?
Conditions on collateral? Market value vs Book value trust?
• Underwrite counterparty exposure to establish internal caps/limits on counterparty
exposure
 Costs to ceding company
Other considerations include…
Full Risk Low Risk
Receive ceding
commission and
forego all future
profits.
Pay fees.
Receive
experience
refund of all
future profits.
Financial Reinsurance

24. 24
US Statutory Financial Results—Revisited
Profit Measure Baseline 50% qs
Coinsurance
Financial
Reinsurance
Internal Rate of Return (IRR) 8.19% 12.08% 11.22%
Becker IRR 9.10%
Return on Assets (ROA) 0.57% 0.69% 0.44%
Profit Margin 4.51% 5.79% 3.73%
Embedded Value @ 8% $0.08 $0.69 $0.67
Before and After Reinsurance
 Coinsurance ceding 50% to Reinsurer in exchange for 1% ceding commission
 Financial reinsurance to finance redundant reserves above CSV
 Both reinsurance structures improve IRR and EV

25. 25
US GAAP Financial Results—Revisited
Profit Measure Baseline 50% qs
Coinsurance
Financial
Reinsurance
Average ROE 6.79% 13.35% 6.92%
Return on Assets (ROA) 1.05% 1.18% 1.31%
Profit Margin 12.40% 16.60% 15.57%
Embedded Value @ 8% -$3.59 -$0.80 -$3.28
Before and After Reinsurance
 Coinsurance ceding 50% to Reinsurer in exchange for 1% ceding commission
• Improves both US GAAP and US Stat results
 Financial reinsurance to finance redundant reserves above CSV
• Modest US GAAP improvements compared to US Stat

26. 26
Conclusions
 FIAs are a popular products that meet client needs
• Upside potential with downside safety. Lifetime income. Best-selling.
 FIAs are complicated
• Features, product design, accounting, hedging, pricing and financial reporting
 By introducing 6-factor DuPont Analysis, we can more clearly see drivers of
product profitability and we can develop methods to improve each
 We can structure annuity reinsurance to improve product returns and/or
product competitiveness

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