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

Table of Contents

2

Motivations for Annuity Reinsurance

Opportunities for Annuity Reinsurance

Annuity Reinsurance Strategies

Longevity Swap Case Study

Summary

Motivations for Annuity Reinsurance

3

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

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?...”

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

Opportunities for Annuity Reinsurance

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…

9

Annuity Reinsurance Strategies

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…

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

2014

2020

2026

2032

2038

2044

2050

2056

2062

2068

$-

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

$30,000,000

$35,000,000

$40,000,000

$45,000,000

Gross Benefit Payments: Expected

Expected Benefits

Years

Am

ou

nts

Pai

d (

in m

ilio

ns)

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… 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%

2014

2027

2040

2053

2066

$-

$10,000,000

$20,000,000

$30,000,000

$40,000,000

$-

$500,000.0

$1,000,000.0

$1,500,000.0

$2,000,000.0

$2,500,000.0

Cash Flows: Expected

Expected Benefits (floating leg)

Reinsurance Premium (fixed leg)

Net Payments to Reinsurer

Years

Gro

ss

Am

ou

nts

(in

mili

on

s)

Ne

t A

mo

un

ts (

in m

illio

ns

)

$-

$50,000,000

$100,000,000

$150,000,000

$200,000,000

$250,000,000

$300,000,000

$350,000,000

$400,000,000

$450,000,000

$500,000,000

$367,591,695

$460,133,614

$92,541,919

Coinsurance: Initial Values

Series1

A sizeable

out of pocket

expense

Payment deferred—upside potential

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Longevity Swap Case StudyApplication of a longevity swap…

2014

2018

2022

2026

2030

2034

2038

2042

2046

2050

2054

2058

2062

2066

$-

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

$30,000,000

$35,000,000

$40,000,000

$45,000,000

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

Years

Am

ou

nts

Pai

d (

in m

ilio

ns)

Benefits typically settle monthly Benefits are especially sensitive to mortality

improvement assumption Collateral as a negotiated item

2014

2019

2024

2029

2034

2039

2044

2049

2054

2059

2064

$(8,000,000)

$(6,000,000)

$(4,000,000)

$(2,000,000)

$-

$2,000,000

$4,000,000

Net Longevity Swap Cash Flows: Se-lected Stressed

Expected

Benefits at 90% qx

Benefits at 110% qx

Benefits at 1.5% improvement

Benefits at 90% qx, 1.5% improvement

Years

Am

ou

nts

Pai

d (

in m

ilio

ns)

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Longevity Swap Case StudyCase study present values…

#Ceding Company Present

Values @ 8%Before

ReinsuranceAfter 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…

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Summary

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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…

Thank you for your attention.

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