The Insurance Side of Stable Value

SVIA Spring ForumApril 15, 2013

Helen M. Napoli New York Life Insurance CompanyMichael J. Rant Prudential FinancialWilliam C. Sample Metropolitan Life Insurance CompanyPhilip T. Maffei TIAA-CREF

The Re-emergence of Insurance Companies in Wrap Market

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Helen M. Napoli New York Life Insurance Company

HistoryThe Sell Side

• Throughout the late 70’s and 80’s insurance company general account products were the only game in town.

• Following the insolvencies of Mutual Benefit1 and Executive Life2 in the early 90’s, banks and insurance companies began exploring alternative product solutions for stable value funds.

• Banks got there first with synthetic GICs --Banker’s Trust was the first major player in this market, introducing the BASIC product in July 1991.

• Relatively few insurance companies entered the synthetic GIC market in the early 90's.

• At the same time, a number of large insurers began introducing guaranteed separate account products in a variety of different structures (e.g., buy and hold, collapsing duration, and evergreen contracts) .

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1An order of rehabilitation was issued in mid-1991 and a liquidation order was issued in 19932 A conservation order was issued in April 1991 and a liquidation order was issued in December 1991

HistoryThe Buy Side

• The 80’s also saw the emergence of third-party intermediaries. At their inception, many of these intermediaries simply performed due diligence and other consultative services for plan sponsors.

• As plan sponsors sought relief from fiduciary liability, these services rapidly evolved into discretionary management arrangements.

• The failure of yet another large insurer, Confederation Life in 19943

accelerated the movement from in-house management to third-party intermediaries.

• Intermediaries that started as stand-alone entities developed strategic alliances with bundled service providers to enhance distribution opportunities.

• Strategic alliances eventually resulted in a change of ownership from privately held firms to investment management firms as new alternative product structures also opened up opportunities for investment management.

• As asset management became consolidated among these firms, tremendous [downward] pressure was put on wrap fees and contractual terms.

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3The Confederation Life receiverships began in Canada, Michigan and Georgia with rehabilitation orders in 1994. Although Confederation was a Canadian insurer, roughly one-third of its business was in the U.S. (according to the National Organization of Life and Health Insurance Guaranty Association (NOLGHA) website).

Advantages/Disadvantages of Wrap Products

Advantages to Plan

• Less exposure to insurer’s credit (through separate account insulation or ownership of the assets by the plan through synthetics).

• Opportunity to participate in investment performance.

• Transparency on underlying portfolio (i.e., asset allocation, duration, credit quality) and fees.

Disadvantages to Plan

• Plan assumes responsibility for credit downgrades/defaults on underlying securities.

• Shorter duration portfolios with more restrictive guidelines (versus general account) lower crediting rates.

• No minimum or floor crediting rate (above zero) which is available in some general account structures.

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History The Regulatory Front

• As insurance companies began introducing new alternative product structures, the industry also saw new regulations developing at the state level.

• A number of states, including states that had previously deregulated GICs or group products sold in the large institutional markets, began developing new contract and plan of operation standards for synthetic GICs (e.g., Pennsylvania, New Jersey and California) and in some cases, guaranteed separate accounts.

• New reserve requirements were developed by individual states (e.g., Regulation 128 in NY, Bulletin 97-3 in Minnesota and Bulletins 95-8 and 95-10 in California) and the National Association of Insurance Commissioners (NAIC) developed new model regulations for these product structures (A-200 and A-695).

• The establishment of the 50 state guaranty fund association was another by-product of the failed insurers of the early 90’s.

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The 2008 Financial Crisis

• The 2008 financial crisis created capacity issues for the stable value market on several fronts:

– Consolidation of banks and increased capital requirements;

– Reevaluation of the banks’ core businesses;

– Pressure on the market-to-book ratios of the underlying asset pools due to credit downgrades;

– Recognition that wrap premiums did not adequately compensate providers for the level of risk being assumed.

• This problem was addressed as new/ previously inactive providers stepped up with new products/expanded capacity. Insurance companies have vast experience in the guarantee business and offer:

– Unique liability management and actuarial skills;

– Experienced investment managers who successfully navigated the 2008 crisis;

– Healthy balance sheets and strong capital/surplus positions.

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The Insurance Company Challenges

• Today’s products are heavily negotiated and highly customized.

• Multi-state regulation makes speed-to-market not so “speedy.”

• Insurers have to deal with 50 state regulation of:

– Company licensing

– Producer licensing

– Product Regulation: i.e., contract provisions, form filings and plan of operation requirements

– Financial Regulation: asset adequacy, reserves, issuer solvency

– Market Regulation

– Consumer Protection and Services

• Renewed regulator interest on previously settled matters:

– Separate Account Insulation

– Reserve requirements

– State Guaranty Fund Coverage

– Risk Pricing

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Insurance Contract General Filing and Issuance Requirements

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Michael J. Rant

Prudential Financial

Specific Filing Requirements Vary by State• In general, prior to issuing a contact the Insurance Company must obtain approval in its

home state as well as any state where it is licensed to do business and it intends to issue a contract

• Insurance Department filings include the following:

– Plan of Operations

– Form of Contract (some states require approval of every contract issued in the state, and will not pre-approve a form

– Memorandum of Variability

– Actuarial Memorandum

• Extraterritoriality Issues

– State may limit what can be done in a contract even issued outside its jurisdiction if the Insurance Company is licensed to do business in that State

• Jurisdictional Issues

– Insurance Company must be licensed for the type of business.

– Contract/Product must be authorized and approved by the state.

– Must be some connection to the state where the contract is issued – ie, location of trust, trustee, or contractholder.

• Contractholder - Group Annuity Contracts may only be issued to an “eligible group”

• There may be additional disclosure or form requirements

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Plan of Operations

• Describes in detail the key operational provisions of the supporting account, investments, and key contract provisions, including:

– Overview of the Synthetic GIC describing relationship between Book Value and Market Value

– Underwriting

– Eligible Investments, Custody of Assets, and Investment Management

– Guarantee of Book Value and how Crediting Rate is calculated

– Asset Adequacy Testing

– Fees

– Annuity Purchase Option

– Termination Rights

– Investment Guideline Constraints

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Contract Form Filing• Provisions Must Comply with any required terms as well as with the Plan of Operation

• Filed with “Brackets” which delineate variable text

– Outside of the Brackets the text is not variable and cannot be changed without filing a new contract form.

– Inside the brackets the text is variable, however still subject to compliance with state regulations and the plan of operations – no Cinderellas allowed in these brackets.

– The variable elements are sometimes described in the “Memorandum of Variability” which describes the areas inside the brackets and the intent of the open text areas.

• Must include certain key contract provisions, which may be found within the regulations or contained in the “Product Outline” published by the insurance department, such as:

– Annuity Purchase Rights

– Unilateral Contract Termination, typically for investment guideline violations

– Discontinuance at Market Value or Book Value installments

– Assets in a segregated account owned by the contractholder

– Audit and inspection rights

– Description of how Book Value and Market Value are determined

– Crediting Rate - formula, duration of guarantee, adjustments to the rate

– Deposit Restrictions

– Language to protect insurance department a "waiver of remedies"

– Annuity Purchase Rate Guarantee

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Contract Form Filing (continued)

• Sometimes Specific language is required, for example: Annuity Purchase Rights

• No waiver of remedies following the breach of any contractual provision or of the Investment Guidelines, or failure to enforce such provisions or guidelines, shall be effective against any insurance department with regulatory jurisdiction over this Contract, including the domiciliary insurance department, unless approved in writing by such domiciliary insurance department or any other insurance department with regulatory jurisdiction over this Contract

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Memorandum of Variability

• The following are some of the requirements that can be found in a state's contract checklist for synthetic GICs:

– The department accepts limited use of brackets. Extensive bracketing indicates that the benefits that affect the rating are subject to change without review by the department. In order for approval, submissions must include a Statement of Variability identifying alternative or replacement language. The use of brackets is limited to the approved alternates filed by the company.

– If in the filed contract there is a need for variability as indicated by the presence of bracketed items, “Statement of Variability” should be prepared to explain the bracketing. The Statement of Variability must specify the range of variation of each variable contract provision and item that could have a material effect on the risk assumed by the issuing company or the contract holder (i.e., items such as names and addresses may be omitted.)

• The following is an example of text that would be contained within a memorandum of variability and cross referenced back to the bracketed section:

– This is subject to modification to conform to the Investment Guidelines mutually agreed to by the Contractholder and Prudential. Investment decisions with respect to the Investment Account will be made in accordance with standards approved by Prudential and set forth in the investment guidelines accompanying each Contract. The Investment Guidelines in all Contracts will conform to Prudential’s internally established investment limits.

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Eligible Group Contractholders

• Defined by State Specific rules, for example may be limited to the following:

• Employer group – A contract issued to an employer which permits employees of the employer to become annuitants

• Employers’ Association Group – A contract issued to an employer’s association which permits all employees of such employers’ association to become annuitants

• Labor Union Group – A contract issued to a labor union which permits all of the members of the union to become annuitants

• Trustees Group – A contract issued to the trustees of a trust established by an employer, labor union or employers’ associations that permit all of the employees to become annuitants

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Eligible Group Contractholders (continued)

• Homogeneous Group – A contract issued to an association of people having a common interest, calling, or profession, constituting a homogeneous group, and permits all members and their employees to become annuitants

• IRC Section 408 (IRA) Group – A contract issued to a bank, trust company, or trustees of one or more trusts which permit individuals to contribute to an individual retirement account or an individual retirement annuity

• Trustees Group II – A contract issued to the trustees of one or more trusts for employees of more than one employer which permits all employees to become annuitants. If all of the funds are contributed by the employer(s), the insurer will issue a certificate to each applicable employee

• Trustee Foundation Group – A contract issued to trustees of a foundation or endowment, and permits specified classes or professionals to become annuitants

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Additional State Requirements• States may have specific disclosure or form requirements, for example approximately 30

states require disclosures relative to limitations on recovery from state insurance guarantee funds

• Example of disclosure language from a state's required notice:

– If the insurer that issued your life, annuity, or health insurance policy becomes impaired or insolvent, you are entitled to compensation for your policy from the assets of that insurer. The amount you recover will depend on the financial condition of the insurer

– Unallocated annuity contracts issued to retirement plans, other than defined benefit plans, established under section 401, 403(b), or 457 of the Internal Revenue Code of 1986, as amended through December 31, 1992, are covered up to $250,000 in net cash surrender and net cash withdrawal values, for State residents covered by the plan provided, however, that the association shall not be responsible for more than $10,000,000 in claims from all State residents covered by the plan

– THE COVERAGE PROVIDED BY THE GUARANTY ASSOCIATION IS NOT A SUBSTITUTE FOR USING CARE IN SELECTING INSURANCE COMPANIES THAT ARE WELL MANAGED AND FINANCIALLY STABLE. IN SELECTING AN INSURANCE COMPANY OR POLICY, YOU SHOULD NOT RELY ON COVERAGE BY THE GUARANTY ASSOCIATION.

– THIS NOTICE IS REQUIRED BY STATE LAW TO ADVISE POLICYHOLDERS OF LIFE, ANNUITY, OR HEALTH INSURANCE POLICIES OF THEIR RIGHTS IN THE EVENT THEIR INSURANCE CARRIER BECOMES FINANCIALLY INSOLVENT. THIS NOTICE IN NO WAY IMPLIES THAT THE COMPANY CURRENTLY HAS ANY TYPE OF FINANCIAL PROBLEMS. ALL LIFE, ANNUITY, AND HEALTH INSURANCE POLICIES ARE REQUIRED TO PROVIDE THIS NOTICE

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Actuarial Filings

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William C. Sample

Metropolitan Life Insurance Company

Actuarial Filings at Contract Inception

• 50 states, 50 regulatory agencies

• Actuarial Memorandums

– Product Description

– Adherence to reserve requirements

– Annuity Rates (Unisex requirements in some states)

• What was once conservative, may not always be

• Other Requirements

– Self-Support Memorandums (NY)

• Each contract must be self-supporting under reasonable assumptions

– Unique requirements for California

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Ongoing Actuarial Requirements

• It’s all about the reserves

• Actuarial Opinions (risk premiums, reserve adequacy, etc.)

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GAAP STATUTORY

Primary Audience Investors Insurance Regulators

PurposeLong-term profitability

Solvency

Reserve Requirements (Separate Accounts)

SOP-03-1NY Reg 128/NAIC Model Law

On-going Testing N/AAsset Adequacy Analysis

New York Regulation 128- A Closer Look

• Step 1: Calculate the Present Value of the Liability (MVGCL)

– Project out Guaranteed Payout at the minimum rate

– Discount that Payout at 104.5% of Treasury spot rates

• Step 2: Apply the appropriate shaves to the assets in the separate account

• Step 3: If result in Step 1 > Step 2, hold the difference as additional reserve in a non-insulated separate account

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New York Regulation 128- A Closer Look

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• Based on a separate account contract with a 3% minimum rate, GV payout after 3 years, assets managed to Barclays Capital Intermediate Aggregate Index

85.0%

90.0%

95.0%

100.0%

105.0%

110.0%

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

$9.00

$10.00

Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12

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GV

Illustrative Reserve Requirement History

Additional Reserves MV/GV

What’s on the Horizon?

• LICONY Recommended Changes for Regulation 128

• AAA presentation to NAIC- Synthetic GIC Reserve Proposal

• NAIC Separate Account Risk Working Group- SA Insulation

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A New Entrants’ Perspective

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Philip T. Maffei

TIAA-CREF

New Entrant Perspective

• Currently working with manager community to issue bundled evergreen separate account GICs (SAGICs) to externally managed SVFs

• SAGIC Program genesis:

– Market demand for “AAA” rated financial strength

– Strong partnerships with prospective SV manager clients

– Desire to leverage core competencies in asset, liability and risk management for alternative channels

– Desire to diversify revenue and AUM sources within approved risk budgets

• Time to market:

– Concept / Thumbnail sketch – April 2010

– First deposit – May 2012

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New Entrant Perspective (Cont’d)

• Bridges To Cross:

– Getting decision-makers, actuarial, risk managers and finance on-board (internal paradigm shift from issuance of spread-based to fee-based)

– Synthetic GIC vs. Separate Account GIC?

– Impact of Dodd-Frank?

– Wrap bundled with asset management

– Why are banks exiting? Why are SV funds closing? New press every few weeks.

– Rating Agencies / capital

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New Entrant Perspective (Cont’d)

• General Process:

– Competitive intelligence gathering

– Rough order of magnitude risk modeling, capital requirements, P&L projections

– Approval in concept from ALCO, Growth Committee, Investment Management Committee, etc. to peel back the onion further

– Cross-organizational team developed (Product, Asset Management, Law, Actuarial, Compliance, Operations, IT, Finance, etc.)

– Product / contract structure development; incorporation of market / partner feedback (terms, reports, timing, etc.)

– Asset Management portfolio management, operations, actuarial and accounting team feedback gathering

– Fine tuning of models, capital requirements, P&L projections

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New Entrant Perspective (Cont’d)

• General Process (cont’d):

– Plan of Operation developed

– External legal review (securities law, ERISA law, etc.)

– Multiple governance approvals (see next slide)

– Filing / approvals of contract template, Plan of Operation (per separate account), Investment Management Agreement (internal), Distribution Agreement (internal)

– Development or enhancements for MV/BV recordkeeping, statutory and investment accounting, actuarial processes, regulatory, internal and external reporting, operational processes, treasury, rate setting process / governance, compliance monitoring, etc.

– Deal-level Implementation Team and SOPs developed

– Underwriting process and capacity reservation policy created

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New Entrant Perspective (Cont’d)

• Governance and approvals (capital at risk, pricing, capacity, on-going monitoring, delegations of authority, modeling / pricing, investment guidelines, guardrails, etc.)

– Asset / Liability Committee (ALCO) and working groups

– Investment Management Committee

– Broker-dealer new product committee

– New Product Committee

– Product and Client Governance Committee

– Finance and Risk Management Committee of the Board

– Board of Directors / Board of Trustees

• Challenges greater than originally anticipated

– Insurance department approvals of Plan of Operations

• Investment guidelines

• In-Kind deposits

• Misc. areas of contention

– Manager-specific contract terms and investment guidelines negotiations

– Governance approvals

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