Session 69 PD, Sharpening the Pricing Pencil. Moderator: Paul Fedchak, FSA, MAAA. Presenters: Paul Fedchak, FSA, MAAA Douglas L. Robbins, FSA, MAAA

Transcription

1 Session 69 PD, Sharpening the Pricing Pencil Moderator: Paul Fedchak, FSA, MAAA Presenters: Paul Fedchak, FSA, MAAA Douglas L. Robbins, FSA, MAAA

2 Session 69PD Sharpening the Pricing Pencil Paul M. Fedchak Douglas L. Robbins May 5, 2015

3 Classic Product Cycle Product Design Experience Analysis Marketing Financial & Valuation Classic Product Development Cycle Pricing Administration Distribution Underwriting Courtesy of Lloyd Spencer, Hannover Re 2

4 Life Product Cycle Risk Management Underwriting Pricing Financial Reporting Analysis of Emerging Experience Administration Product Design Policy Form Filing & State Approvals Marketing / Illustration Actuary Development of Pricing Assumptions Valuation / Appointed Actuary Distribution Courtesy of Lloyd Spencer, Hannover Re 3

5 Markets and Profit Measures 4

6 Life Product Market Protection Term ULSG Current Assumption UL Final Expense LTC/Combo Accumulation Whole Life Accumulation UL Variable UL Indexed UL What drives the market for various products? Interest Rates/Equity Returns Regulation Policyholder Optionality Population Demographics 5

7 Profit Measures How should I measure profit results on Life Products? Where should I set my profit target? Do I hit my profit target on all cells? 6

8 Trading Salads for Yummy Food All I have to eat is salad, but I think that having better tasting food will improve my life Salads are necessary for basic sustenance, but: I want to maximize my enjoyment of the food If I only have salad, I will not eat enough calories to do basic daily tasks, and will enjoy my food minimally If I have no salad, I will maximize enjoyment. But if I have too many calories, I may have health issues 7

9 Trading Salads for Yummy Food I can trade my salad for one of three other food options: Chicken Noodle Soup from Katz s Deli A Slice of Pizza from John s (the Original) Porterhouse & Lobster Surf & Turf Special from Keen s with all the fixin s How do I decide for which food to trade? What questions do you ask? 8

10 Trading Salads for Yummy Food How much will I enjoy each food? How many calories are in each food? How much salad do I have? What is the minimum amount of salad I need to remain healthy? How much of each food can I obtain in a trade for my salad? What if the salad suddenly tasted like French Fries? 9

11 Profit Measures I m a pricing actuary, why are we talking about food? Salad = Surplus Enjoyment = Return on Investment I should consider when setting my target profit: How much surplus a product absorbs (or salad I trade for enjoyment) How much surplus earns (how much I enjoy the salad) How much risk am I taking on (too many calories?) How are profit targets usually set? 10

12 Annuity Profit measures ROI, ROA, and The Market 11

13 Annuity Product Market Deferred Fixed, w/ or w/o MVA Variable Indexed Deferred Income Annuity ( DIA ) Immediate SPIA Hybrid Forms Guaranteed Withdrawal Riders Flat ~= Immediate Credit ~= Deferred Often a tradeoff between need for liquidity and eventual income amount 12

14 An Offer They Can t Refuse Say you get a call from a friend They are very excited about an offer they just got, to invest $1,000 in hog futures After a year, they will receive $1,900 if the market is good, or lose the $1,000 if not They estimate the odds at 50/50; even your friend knows the expectation is $50 However, the salesman has also told the friend, But wait, that s not all!! 13

15 An Offer They Can t Refuse By entering the first transaction, they gain the option to invest $5,000 in hog company stock: expected return 20% At the end of the year, they will either have made the first $1,000 back, or they will be up $1,900 all told The expected return of $950 is a 16% return on the deal, and they can t lose!! What do you tell your friend? 14

16 An Offer They Can t Refuse Too risky? Okay, what if they have some insider trading insight, and live in a place where that s legal? 15

17 An Offer They Can t Refuse Too risky? Okay, what if they have some insider trading insight, and live in a place where that s legal? (Say Wall Street) 16

18 An Offer They Can t Refuse Too risky? Okay, what if they have some insider trading insight, and live in a place where that s legal? (Say Wall Street) Okay, kidding, but assume the return is 5%, but now truly is risk free? Is the hog deal now a good one? Why or why not? 17

19 Why does this matter? Let s say company ABC is pricing a Variable Annuity ( VA ) over 7 years 7 year linear CDSC 7% >0%; vanilla on most assumptions, 100% lapse EOY 7 They solve for an 8% upfront cost, and a 1.05% all in fee/fund profit They assume the market will return 10% per annum, and they get an expected ROI of 10% What do you think the ROI will be if the market returns something other than 10%? 18

20 Of Course Not!! Actually, the graph of ROI versus assumed market return is illuminating 19

21 What is the Intent? Is company ABC trying to buy into the stock market, at a leveraged pace? Why not just invest their surplus directly, and tighten their ROI results? Is it possible that expected ROI isn t telling them all they need to know? Would hedging help tell you the value of the base investment? (If so, not good.) 20

22 ROI vs. RBC / Target Surplus Is there anything else that could go wrong, regarding ROI? Investing as we do in the fee structure of a VA, gives us the opportunity to hold these surplus assets The assets there will be fixed rate ones Not unreasonable to assume a known return But that return is much lower (like my example) This disguises the risk in the product ROA gives a cleaner look at just the product 21

23 Solving for Trail Commission Say they want to look at trail options, and hold market expectation at 10% Base ROI is again about 10% They ask 2 students to solve for trails The first student gets 2.5%/1% upfront/trail The second gets 5.25%/0.50% Someone in sales then points out that a level 4% trail has a much higher ROI about 174%?!? Again, the problem is with ROI as a concept 22

24 In Summary: ROI versus ROA ROI is not going away, re annuities: Allows you to rank investment choices by return Relates somewhat to GAAP ROE Good for comparing to a required hurdle rate HOWEVER, it never informs you about dollars of profit AND you really should examine tail ROIs ROA, in addition to helping with risk (when fat ) helps lift the veil on: Contribution to surplus, per unit of sales The masking effects of reserves and RBC Future risk to surplus, if assumptions don t pan out 23

25 Modeling 24

26 How Do Pricing Models Differ From Reality? Depends on Product On the Extremes: Term vs. IUL Term: An Excel Spreadsheet Might Get Pretty Close Assumptions can always deviate from reality In the middle IUL Reserve Financing Regulation Hedging Programs Index Crediting Equity Scenarios Which account are charges deducted from? When? 25

27 How Do Pricing Models Differ From Reality? General Marginal Expenses vs. Fully Allocated Term Grace Periods UL VM 20 and Principles Based Reserves IUL Reality: Every premium creates a new indexing bucket Model: How much time do you have? Reality: Complex Hedging Program Model: Assume Hedge plus Slippage? 26

28 Modeling How often is stochastic pricing used for life insurance? How Sensitive are Results to Stochastic Scenarios? What modeling challenges face pricing actuaries going forward? Continual movement toward increasingly complicated product designs Reserves moving toward principles based (and projection based) Riders (especially Critical Illness, Accelerated Death Benefit, etc.) Financial Reinsurance 27

29 Annuity Modeling 28

30 Annuity Modeling & Risks ALM and stochastic testing helps you look at some of the obvious ones Reinvestment risk and Disinvestment risk on Fixed products particularly Book Value Guarantees on all products Having fully robust models helps ensure you aren t missing others Question: why not just use single cells? Question: why not test one guarantee at a time? 29

31 Another Common ROI variance For most profit measures you ve seen, weighted averages work fairly well For ROI, this is less true, and for annuities, this can raise an issue Example An SPDA has an ROI of 10% at most ages, ~90% of sales Because of reduced commission, my ROI of older ages (10% of sales) is 20% The block s average ROI is likely to be very close to 10% not 11% why? 30

32 Mortality, and Average Issue Age If you sell equal parts issue age 60, 70, and 80, what is Average Issue Age? You were right to again suspect a trap Depending on your mortality assumption, the answer is likely ~73 Moral: The more important your early mortality rates are to profit, the more pricing ages you ought to use 31

33 Holistic versus Limited Pricing I want to price an Indexed Annuity with both a Living and a Death Benefit I price each one out individual, and come up with required charges What is likely to happen? Should I also be including my base product profit? Why or why not? 32

34 Assumptions 33

35 Assumptions Life Products General Mortality Expenses Permanent Particularly Older Age Mortality What experience is available? What were the underwriting standards when the business was written? How will mortality improve going forward? What about Lapses Economic Environment/Interest Earned 34

36 Policyholder Behavior Life Products Premium Funding Lapses/Surrenders Tail Catchup Behavior and Anti Selection Policy Loans and Withdrawals (Accumulation Products) 35

37 Assumptions Imagine your company produces widgets A client wants to enter into a contract to buy widgets over the next 5 years In the contract, the client wants: 10 widgets in year 1 5 widgets in year 2 An option to buy between 0 and 10 widgets each year in years 3 through 5 Widgets must be delivered immediately once the client requests the number Relatively speaking, how much should you charge for the widgets in each year? 36

38 Assumptions On one hand, you know you will be selling the 15 widgets in year 1 On the other hand, the # of widgets I need ready in years 3 5 is uncertain What if the client asks for the first year s widgets to be free? 37

39 Assumptions Life Products What assumptions are you most confident in? More confident in early year assumptions than out in the tail Widgets = claims First year free = strain Is there enough profit in the tail to account for the assumption uncertainty? 38

40 Annuity Assumptions 39

41 Types of Expense Risk Fund/Asset related Administrative/Per policy Inflation 40

42 Annuities and Expense Risk As essentially spread based products, annuities are highly prone to this type of risk You defend against variances in fund based expense mostly with a thick ROA; tricky for VA How about the other types? Size is king! Here s why

43 Thoughts on Mortality In vanilla SPDAs, almost a non issue For others, anti selection a much bigger worry than long term trends Generally true.... Possible exception DIA When is a chargeback crucial? What else could cause anti selection? What else is important? (This mortality topic segues well into seminar to follow!) 42

44 About Annuity Behavior 43

45 Inforce Management 44

46 Inforce Management Experience Studies Mortality Expense Lapse/Surrender Analysis of Variance How do I separate base policy from riders? How do identify which cohorts of policies are driving overall results? Who is buying? Do my actual sales line up with my assumed distribution? 45

47 Annuity In Force Management 46

48 In Force We ve covered Actuarial Assumptions What other items are a concern re spreads? Investment underperformance Investment lag Rate lock, especially on large cases Credited Rate reset strategy tug of wars Task: 1) Find out who does experience studies; and 2) Take them to dinner Only YOU know what you wish you d known for sure, when developing your product 47