Extract from. Études et Dossiers No th Meeting of The Geneva Association s Amsterdam Circle of Chief Economists

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1 International Association for the Study of Insurance Economics Études et Dossiers Extract from Études et Dossiers No th Meeting of The Geneva Association s Amsterdam Circle of Chief Economists February 2011, Amsterdam & 7.5 th International Liability Regimes Conference of The Geneva Association 17 June 2011, Beijing This document is free to download from The Geneva Association website, August 2011 Working Paper Series of The Geneva Association Association Internationale pour l'etude de l'economie de l'assurance The Geneva Association - General Secretariat - 53, route de Malagnou - CH-1208 Geneva Tel.: Fax:

2 The Geneva Association Working Paper Series Études et Dossiers appear at irregular intervals about times per year. Distribution is limited. The Études et Dossiers are the working paper series of The Geneva Association. These documents present intermediary or final results of conference proceedings, special reports and research done by The Geneva Association. Where they contain work in progress or summaries of conference presentations, the material must not be cited without the express consent of the author in question. The opinions expressed in Geneva Association newsletters and publications are the responsibility of the authors. We therefore disclaim all liability and responsibility arising from such materials by any third parties. This document is free to download from The Geneva Association website, please visit:. Layout & Distribution: Valéria Kozakova The Geneva Association Association Internationale pour l'etude de l'economie de l'assurance

3 Next Generation Lifetime Income Guarantees: Risks and Opportunities Jacob Herschler Agenda What are Guaranteed Lifetime Withdrawal Benefits? Risks in Guaranteed Lifetime Withdrawal Benefits Self-governing mechanisms to dampen risk The future: Unbundled Guaranteed Lifetime Withdrawal Products 2 8-1

4 Brief History In the decades preceding this century, individual variable annuity products grew to become a vital part of the U.S. life insurance industry VA buyers rarely exchanged their variable annuity account balance for a stream of guaranteed lifetime income Guaranteed lifetime withdrawal benefits (GLWBs) were introduced by most U.S. variable annuity issuers in recent years GLWBs have become the driving force behind VA sales today Maintaining investment control and flexibility regarding retirement investment balances trumps desire to maximize retirement income. More subtle risk-pooling than traditional annuitization 3 Locking In the Basis of Lifetime Income Guaranteed Lifetime Withdrawal Benefits lock in highest account values on a periodic basis for income purposes The client purchases a Variable Annuity with a Guaranteed Lifetime Withdrawal Benefit This is a hypothetical example for illustrative purposes only. It does not reflect a specific annuity or the performance of any investment

5 Determining Withdrawal-Based Lifetime Income ACCOUNT VALUE PWV $115,000 PWV $140,000 PROTECTED WITHDRAWAL VALUE (PWV) INITIAL PURCHASE PAYMENT AND PWV $100,000 Insurer s General Account Age Dampening Risk Through Product Design Three Risks Longevity Risk Client Behavior Risk Capital Markets Risk Product design levers which risks to take and which to avoid? Level of guarantees Investment platform constraints Limit purchase age or age of first lifetime withdrawal Self-governing mechanism aimed at capital markets risk 6 8-3

6 Dampening Capital Market Risk Self-governing mechanisms within the product that reduce risk based on external market conditions Asset allocation limitations Require investment funds that shift weight to fixed-income income holdings when the fund s equity positions are weakening Requires a mathematical formula that transfers investors assets between equity and fixed-income income investments based on impact of market fluctuations Insurer s hedging capabilities Expertise, modeling tools, market access 7 Product Embedded Risk Management Account Value S&P 500 1,600 $600,000 1,400 $500,000 1,200 $400,000 1, $300, $200, $100, $0 0 Protected Withdrawal Value (+17.7%) Account Value with HDI (+9.0%) Account Value w/out HDI (-0.69%) S&P 500 (-7.0%) % of HD Account Value Invested in AST Investment Grade Bond Portfolio The historical returns shown are used to demonstrate how this annuity could operate, and should not be deemed a projection or prediction of future rates of return. The illustration includes the following assumptions (i) fund expense of 1.08% (which reflects the annual expenses of the AST Balanced Asset Allocation Portfolio, available for investment in conjunction with HD Lifetime Income); (ii) Highest Daily Lifetime Income charge of 0.95% which is assessed four times a year (0.2375% each quarter) based on the greater of the account value and the Protected Withdrawal Value (adjusted for withdrawals and purchase payments); and (iii) Insurance and Administrative Charges of 1.30% (which reflects the charge of the Prudential Premier Retirement Variable Annuity B Series SM variable annuity). Other annuity products and investment options may contain different expenses. Hence, the values illustrated may result in performance that is higher or lower than the performance shown in this illustration

7 Future: Unbundled Lifetime Income Guarantees Making life-contingent income guarantees based on the performance of equity-linked accounts is a long-established role of life insurers Basing life-contingent income guarantees on the performance of an investor s equity-linked account held at a separate financial institution is the next natural step for Guaranteed Lifetime Withdrawal Benefits Today, global life insurers provide lifetime income guarantees on a small fraction of investment accounts investors intend to tap for income during retirement. Insurers will apply variable annuity product design and risk management learning to these new products 9 Conceptual View of an Unbundled Lifetime Income Guarantee Partnership Model Partner* Investor s s Assets Managed under approved risk portfolios Customer Service Point of sale Post sale Net account value &cashflow data Information sharing Life Insurer* Guaranteed Lifetime Income Product Income Guarantee Administration Service desk for asset manager Management of guidelines Settlement of benefits and fees *Responsibilities listed are illustrative only, and not a complete listing

8 Conclusion Retaining control and flexibility trumps maximizing income Annuitization rarely elected Vast majority of U.S. variable annuity buyers elect optional GMWB feature at purchase Product design and financial risk management for GMWBs tested in recent financial crisis Unbundled lifetime withdrawal guarantees are coming

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