Session 29 PD, Disability Insurance in a Low Interest Rate Environment. Moderator/Presenter: Daniel J. Fix, FSA, MAAA

Transcription

1 Session 29 PD, Disability Insurance in a Low Interest Rate Environment Moderator/Presenter: Daniel J. Fix, FSA, MAAA Presenters: Tasha S. Khan, FSA, MAAA Jacob O. McCoy, FSA, MAAA

2 Disability in a Low Interest Rate Environment Dan Fix, FSA, MAAA RGA Reinsurance Company Jacob McCoy, FSA, MAAA Principal Financial Group SOA Health Meeting June 15, 2015

3 Agenda Introductions and Overview Why are interest rates so low? Impact to Insurance Products Responses to low interest rates 2

4 Sustained Low Interest Rate Environment Paper Recent paper by Rudolph Financial Consulting Sustained Low Interest Rate Environment: Can it Continue? Why it Matters 3

5 Current Interest Rate Environment 10-Year Treasury Constant Maturity Rates 4

6 Drivers of Low Interest Rates Low growth Since % Since % Improved productivity Monetary policy 5

7 Drivers of Low Growth Velocity of Money Demographics Headwinds 6

8 Velocity of Money 7

9 Demographics Aging population Labor participation rates 8

10 Headwinds Article by Robert Gordon identifies six headwinds 1. Female workforce 2. College graduation rates 3. Inequality 4. Movement to low cost regions 5. Sustainability 6. Government actions and debt 9

11 Headwind #1 Female Workforce 10

12 Headwind #2 College Graduation Rates 11

13 Headwind #3 Inequality 12

14 Headwind #4 Movement to Low Cost Regions 13

15 Headwind #5 Sustainability 14

16 Headwind #6 Government Actions and Debt 15

17 Japan Insurance Market Long period of low interest rates 16

18 Japan Market Reaction Product changes Expense management Alternative asset classes Changes in company landscape Regulatory changes 17

19 Impact on U.S. Insurance Market Different for each company Impact varies based on product type Life Annuities Property and Casualty Health Pensions 18

20 Impact on Disability Insurance Reserve Calculations Pricing Financial Reporting Risk Management 19

21 Disability Pricing Example Assume $1000 in premium, 75% TLR, 15% expenses and 10% profit. Assume that 70% of claims are reserves Normal 1% Decrease Profit Neutral Premium $1,000 $1,000 $1,026 Paid Claims $225 $225 $225 Reserves $525 $551 $551 Expenses $150 $150 $150 Profit $100 $74 $100 20

22 Company Discount Strategy Companies reacted to the interest rate decline at different times Multiple discount rate adjustments over the 4 year period 21

23 Company Discount Rate Changes 2011 and 2012 Quarter Company 1Q Q Q Q Q Q Q Q 2012 A B C D E F G H I J K L M 22

24 Company Discount Rate Changes 2013 and 2014 Quarter Company 1Q Q Q Q Q Q Q Q 2014 A B C D E F G H I J K L M 23

25 Possible Responses to a Low Interest Rate Environment Communicate lower earnings expectations to stakeholders Increase prices Adjust product features Alternative investment strategies 24

26 Case Study Background: Accounting Frameworks Principle Audience Assets Liabilities US GAAP Shareholders, Analysts, General Public SFAS 115 defines asset categories. Assuming AFS, assets are held on a market value basis with differences between market value and book value going through other comprehensive income (OCI). Allowance for market value (SFAS 133, SFAS 157) but, in general, liabilities are book value. US Statutory Regulators, Rating Agencies Book Value Book Value Economic Basis Management, Internal Market Value Stakeholders, Foreign Parent Market Value / Best Estimate 25

27 US GAAP Accounting Framework SFAS 60 applies to pre-scheduled products (term, whole life, individual disability). SFAS 60 applies also to Group Disability but is usually considered a short term product. Assumptions are typically best estimate with a provision for adverse deviation (PAD). Assumptions are locked in, unless there is a loss recognition event. As market rates fluctuate, inforce reserves are generally not impacted. 26

28 SFAS 115 Asset Classifications Simple Example Par Value 1000 Coupon Rate 0.08 Semi Coupon 40 Market Value 1, Current Yield 0.07 Hypothetical Market Value Time Investment Coupon Book Value MV , , , , , , , , , , ,

29 SFAS 115 Asset Classifications Held to maturity (HTM) Hold at book value on the balance sheet Restricted trading Trading Hold at market value on the balance sheet Changes in market value will impact net income Available for sale (AFS) Hold at market value on the balance sheet Changes to market value will impact OCI 28

30 SFAS 115 Asset Classifications Considerations Asset / Liability Management if liabilities are a book value and assets are on a market value then you have mixed attributes. Will result in fluctuations in earnings and GAAP equity. Flexibility HTM has restricted trading. If you sell HTM assets all assets might need to be reclassified as trading. Transparency book value accounting does not reflect the current market s valuation. Time horizon insurance liabilities are long-term in nature and market fluctuations are often not the focus. 29

31 Case Study Overview Disability portfolio could be either individual or group SFAS 60 liabilities, No DAC Assets held on an AFS basis to provide flexibility in trading while also matching book value of liabilities Case study will test various interest rate scenarios and investment strategies 100M in annual premium, growing at the rate of inflation 30

32 Case Study Snapshot 2015 Income Statement Premium 100,000,000 Investment Income 34,020,000 Fees 0 Reserve Change 12,600,000 Paid Claims 93,000,000 12/31/2014 GAAP Balance Sheet Market Value of Assets 789,584,160 DAC 0 GAAP Reserves 600,000,000 GAAP Equity (Including AOCI) 189,584,160 Accumulated Other Comprehensive Income 33,584,160 GAAP Equity (Excluding AOCI) 156,000,000 Expenses 15,000,000 Pre-Tax Profit 13,420,000 Taxes 4,697,000 Operating Earnings 8,723,000 31

33 Interest Rate Scenarios Base scenario gradually increasing yield curve Continued low interest rate environment Spike scenario continued low interest rates but then a spike in interest rates during year 3. Bond Duration Current Yield 2-Year 1.0% 10-Year 3.5% 30-Year 4.5% 32

34 Investment Strategies Buy and hold 10-year corporate bonds, duration match liabilities. Buy and hold 2-year bonds followed by 10-year bonds. Duration of assets is initially lower than liabilities. Buy and hold 30-year bonds, duration of assets is longer than liabilities. 33

35 Results of Case Study PV Operating Earnings Interest Rate Scenario Base Scenario Low Interest Rates Spike Scenario 10-Year Bonds Investment Strategy 30-Year 2-Year / 10-Year Bonds 42,108,267 54,449,107 38,168,737 36,054,297 46,881,644 30,868,415 45,844,649 59,119,585 48,374, % 91% 130% 86% 129% 106% 34

36 Compare Investment Strategies Base Scenario PV Operating Earnings 8,000,000 7,000,000 6,000, Year Bonds 2-Year / 10-Year 5,000,000 4,000,000 3,000,000 2,000,000 1,000,

37 Compare Investment Strategies Low Interest Rate Scenario PV Operating Earnings 8,000,000 7,000,000 6,000, Year Bonds 2-Year / 10- Year 5,000,000 4,000,000 3,000,000 2,000,000 1,000,

38 Compare Investment Strategies Low Interest Rate Scenario 12,000,000 Operating Earnings 10,000,000 8,000,000 6,000,000 4,000,000 2,000, Year Bonds 30-Year Bonds

39 Compare Investment Strategies Spike Scenario Operating Earnings 20,000,000 18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000, Year Bonds 2-Year / 10-Year

40 Spike Scenario Risk Management and OCI 12/31/2016 GAAP Balance Sheet Market Value of Assets 804,073,541 DAC 0 GAAP Reserves 624,240,000 GAAP Equity (Including AOCI) 179,833,541 Accumulated Other Comprehensive Income 17,531,141 GAAP Equity (Excluding AOCI) 162,302,400 12/31/2017 GAAP Balance Sheet Market Value of Assets 694,239,001 DAC 0 GAAP Reserves 636,724,800 GAAP Equity (Including AOCI) 57,514,201 Accumulated Other Comprehensive Income -108,034,247 GAAP Equity (Excluding AOCI) 165,548,448 39

41 Conclusions Interest rates are influenced by various macroeconomic, demographic, and market forces. Future yield curve is not know with certainty and past predictions have often been wrong. Classic ALM assumes an economic basis US GAAP accounting assumes stakeholder perspective is long-term in nature 40