History of Variable Annuities 101: Lessons Learned. Ari Lindner

Transcription

1 History of Variable Annuities 101: Lessons Learned Ari Lindner

2 Image: used under license from shutterstock.com Course Title: History of Variable Annuities 101 Today s Topic: Lessons Learned Equity-Based Insurance Guarantees Conference November 15, 2016 ( hours) Ari Lindner

3 Welcome to Class Variable Annuity History Variable Annuities Infancy Tax-advantaged retirement savings vehicle Administered by insurance company Primary competitive advantage vs mutual funds: tax-deferred growth Considered insurance due to a (theoretically over-)conservative annuitization option Annuitization option rarely used Maybe a Return of Premium GMDB? Pricing / Risk Management / Regulation practically non-existent 2

4 Welcome to Class Variable Annuity History Variable Annuities Tumultuous Youth GMDB ROP Reset Ratchet Roll-up GMAB GMIB GMWB GLWB Enormous Growth / Profits / Returns for Insurers / Reinsurers Except Oh, and except Pricing / Risk Management / Regulation struggling (failing) to keep pace with product innovation 3

5 Welcome to Class Variable Annuity History Variable Annuities Middle Age Era of relative stability over past 5 years Heightened concentration of sales in top companies Top 5 50% market share Top 10 75% market share Several major sellers exited Product guarantees rolled back to be more conservative Fund restrictions to allow for improved hedge-ability Low interest rate environment challenging to guarantee pricing Pricing / Risk Management / Regulation fairly robust but still lagging 4

6 Lesson #1 Successful Products will be copied, but should they? Every successful new product innovation has been copied quickly Enhanced GMDB, GMIB, GMWB, GLWB Competitive advantage does not last long But just copying a prospectus leads to problems Is your sales force qualified / trained to sell the guarantee? Can you administer the guarantee properly? Do you understand the risks and have appropriate risk management? Minor changes can result in huge problems (Allmerica, e.g.) 5

7 Lesson #2 Past Performance is no Guarantee of Future Results 20 years ago arguments between actuaries and bankers Is the VA guarantee insurance or is it a derivative? How should it be priced? Actuaries argued: Historical / real world modelling Bankers argued: Black-Scholes (Risk-Neutral) option pricing Late 1990s proliferation of reinsurers Back-tested hedging strategies The 10-year Treasury can never go below 2.5% 6

8 Lesson #3 Policies last a Looong Time Things Change! Policyholder behavior patterns the old days Persistency is negligible at durations 10+ Lapses spike at end of Surrender Charge period to 50%+ Agents move policies when Surrender Charge period ends Nobody will every do that Example: Use the dollar for dollar partial withdrawal feature in an antiselective manner Accounting GAAP (FAS133 / FAS 157), Stat (AG43), RBC (C3P2) Changing regulations / market environment / tax code can significantly alter the risk profile of the guarantee 7

9 Lesson #4 Antiselection VA guarantees add mortality / longevity risk to a non-underwritten (guaranteed issue) product Experience studies show: Higher mortality for policies with enhanced GMDB Lower mortality for policies with enhanced GLB (GMIB / GLWB) Policyholder Behavior Lapse / Withdrawal more rational for larger policy sizes Investment allocation / fund switching no evidence of significant antiselection in the US (yet) 8

10 Lesson #5 Withdrawals Dollar for dollar withdrawals introduced in the wild and lawless 1990s It s just easier to administer / explain Why is that a problem? Nobody will ever do that Hybrid withdrawals For GMIB with 5% roll-up, withdrawal of (up to) 5% annually treated as dollar-for-dollar Effectively a 5% payout annuity with a guarantee that the initial deposit can be annuitized Recent public announcements suggest this feature is being used and may result in future losses on legacy books 9

11 Lesson #6 Policyholder Behavior can Change Nobody will buy a guarantee costing over 30bp OK, 50bp 75bp 100bp Spike lapse at end of SC period of up to 50%+ Even ignoring in-the-moneyness, this lapse patter has substantially changed Agents no longer move the policy before the 10 th duration Behavior has become more efficient over time Lapses and withdrawals are more sensitive to ITM-ness compared to historical experience A more significant regime shift after

12 Lesson #7 Policyholder Behavior can vary by Location / Company US versus Asia (Japan or Taiwan) Investment allocations US often diversified portfolio goal is to successfully build a retirement fund with guarantee used for emergencies only Asia often 100% of funds in riskiest available fund take a big gamble and game the guarantee Antiselective / rational behavior far more prevalent in Asia Lapse / annuitization / withdrawal behavior significant variation by company Can vary by 3x-5x or more, even for similar policy features Driver of variations remains unclear 11

13 Lesson #8 Investments Policyholders are lousy market timers More likely to reduce (rather than increase) equity exposure after severe market drop Account value misses subsequent equity market recovery Was that considered in pricing or hedging strategies? Hedged indices can be a lousy proxy for actively managed funds Equities can be a lot more volatile than expected did you hedge vega? Has resulted in shift away from actively managed funds towards Index funds Vol Controlled or Target Vol funds 12

14 Lesson #9 Regulation is Slow to React Product Development consistently outpaces regulation AG34 lagged GMDBs by several years AG39 lagged GMIB by several years Intended to be temporary when it became obvious that a permanent reserve standard for GLBs would take too long AG43 took 10 years to finalize a GLB reserve methodology In the process of being changed because it does not function well FAS 133 / FAS 157 / FAS 159 which guarantees are derivatives? RBC C3P2 totally disconnected from Stat or GAAP methodologies Market events outpace regulation as well demonstrated weaknesses in existing regulations 13

15 Lesson #10: Hedging No Hedging Delta Hedging Failed in Delta Hedging Multi-Greek Hedging Delta, Gamma, Rho, Vega Failed in Hedging goals are somewhat mutually exclusive GAAP income statement vs Statutory capital vs Long-term economics Even robust hedging strategies have breakage Balance liability matching vs over-trading (buy low / sell high) Non-Hedgeable Risk Financial: basis, correlation, etc. Non-Hedgeable Risk Non-Financial: mortality, behavior, etc. 14

16 Lesson #11 Consistency vs Flexibility Some companies have been successful with a more consistent approach to the market Don t respond to every event with product changes, etc. Don t dramatically increase / decrease sales (or leave market) But in other cases failing to respond can exacerbate problems Slow to adjust poorly designed products or risk management Slow to de-risk products Slow to increase price / accept low rates / accept new behavior data Are you ahead of the market proactive vs reactive? If reactive, are you over- or under-reactive? 15

17 Lessons #12+ What Might We Learn in the Future? CPPI may be impossible in practice Can you move that much equity to bond in that timeframe Will the industry selling equities drive them down more? Policyholder behavior may become more efficient / rational / antiselective Improved advice due to DoL, online / apps, etc. What will impact of voluntary buy-outs be on remaining policies? Longevity risk on GMIB and GLWB may be significantly underappreciated and under-recognized Hedging programs even on vol-controlled funds can blow up again 16

18 Final Thoughts What is next for Variable Annuities? Variable Annuities A Leisurely Retirement? Stable / slowing sales with negative net flows Causes DoL / fiduciary rules or other relatively benign regulatory changes Guarantee price / benefit becomes unattractive Persisting low interest rates Companies (and investors and regulators) seeking products with fewer long-term guarantees 17

19 Final Thoughts What is next for Variable Annuities? Variable Annuities Death? Rapidly slowing sales with companies exiting the market Causes Severe market downturn resulting in losses and increased capital requirements Significant regulatory or tax changes Companies can no longer earn sufficient return on capital on VA Increase in longevity risk (real or perceived) Demographic changes 18

20 Final Thoughts What is next for Variable Annuities? Variable Annuities Reincarnation? Substantive change reinvigorates VA product line Causes Customers demand (and will pay for) longevity, health care, LTC protection in retirement savings products Tax or regulatory change improves VA value proposition High interest rates / low volatility allow for improved guarantees Internet sales model significantly reduces VA cost 19

21 Image: used under license from shutterstock.com Course Title: History of Variable Annuities 101 Today s Topic: Lessons Learned Equity-Based Insurance Guarantees Conference November 15, 2016 Ari Lindner