Life 2008 Spring Meeting June 16-18, Session 75, Selling Annuities through IMOs. Moderator Ghalid Bagus, FSA, FIA, MAAA

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1 Life 2008 Spring Meeting June 16-18, 2008 Session 75, Selling Annuities through IMOs Moderator Ghalid Bagus, FSA, FIA, MAAA Authors Ghalid Bagus, FSA, FIA, MAAA Christopher L. Conklin, FSA, MAAA Yan Fridman, FSA, MAAA

2 SELLING ANNUITIES THROUGH INDEPENDENT MARKETING ORGANIZATIONS: The IMO s Perspective Chris Conklin, FSA, MAAA, MBA Insurance Insight Group June 17, 2008 MY BACKGROUND 15 years in the home office of a major annuity carrier that sells through IMO s, in various actuarial, product development, and marketing roles 5 years working in and with IMO s to build their businesses, and with carriers to expand their IMO relationships

3 TODAY S TOPIC How IMO s choose carriers and thus, how carriers can win IMO business The key elements: Product line Relationship Compensation Service HOW IMO S CHOOSE CARRIERS What IMO s want from a carrier 1. Product line Broader is better, because: I know you will always have a competitive product, no matter what the market conditions, and thus my investment in recruiting and training is protected You will have appeal to more agents, thus I am more likely to hit production bonus levels with you year after year

4 HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 1. Product line If you can t give me broad, give me some differentiating feature that makes you very appealing to a specific market niche, because: You have given me something I can advertise and use to motivate an agent to work with me rather than his existing IMO HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 2. Relationship Relationship means your people come to see me, because: From a distance, carriers tend to look and act similarly Relationship is what makes me trust you and personally desire to work with you We are people, too, and we like to be appreciated

5 HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 2. Relationship Relationship means you invest money up front to build your business with me, because: That makes it more cost-effective for me to build my business with you rather than with someone else It recognizes that your marketing dollar is more effectively utilized in partnership with me than on your own HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 3. Compensation Compensation means sufficient spread over the street compensation, because: I need to pay my staff and my operating expenses, and that s not free I have a choice of where to direct the business, so why would I direct it to where I make less money?

6 HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 3. Compensation Compensation means restricted access to your product, because: That allows me to present myself to an agent as having an advantage over other IMO s I may be able to sign up other IMO s under my contract and earn a spread on that business HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 4. Service Service means you keep my agents informed Website access to business status, open requirements, commissions, forms, and marketing materials

7 HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 4. Service Service means you solve problems Reliable follow-up to issues that I or one of my agents discuss on the phone with your staff HOW IMO S CHOOSE CARRIERS, continued What IMO s want from a carrier, continued 4. Service Service means you work hard to get money transferred Making the sale is the agent s battle alone, but getting the money is a partnership between the agent and the carrier

8 HOW TO GET STARTED How do you get us to listen to what you have to offer? Develop an offer that will appeal to us. Have someone we know and trust deliver the offer. MORE INFORMATION Pick up a copy of our white paper How to Build New Distribution Channels and Grow Sales Volume Quickly at

9 Pricing Fixed Annuities Yan Fridman Head of Annuity Financial Analysis & Value Management ING US Wealth Management June 17, 2008 IMO Characteristics Active management of blocks should expect economic anti-selection MYGAs with window popular Example: 9 years of surrender charges, but after five years a 30 day window for surrendering without SCs. MVA features frequently dropped during window MVA offers imperfect disintermediation protection anyway Major shock lapse at window even with new money rates ARs; one year guarantee, trust me products still sold Care needed with minimum guarantees 20-30% shock lapse at end of SC period page ING North America Insurance Corporation

10 Pricing MYGAs for IMOs Size of shock lapse at window key to profits Without new money rates, lapses will be 70-80% or worse Rolodex effect Implication for investing: Investments should be matched to an assumption that at least 80% of the liabilities will lapse Safer to use a 100% assumption Cash flow match If new money rates are offered and at least a partial commission, may be able to get shock lapse down to 50% With new money rates, commission upon renewal, and active conservation program (outreach programs, conservation product), may be able to get to 40% or lower page ING North America Insurance Corporation Pricing MYGAs for IMOs May take into account post window profits for pricing Thus ALM model is typically distinct from pricing model Strong dynamic modeling could make the two the same Be cautious IMOs unabashed about helping agents exploit the window See it as part of their value added proposition Make sure all costs (renewal commissions, costs of conservation programs, etc.) are reflected in pricing. Strong ALM metrics (duration, convexity, key rate durations) and cash flow management (liquidity) more important than stochastic pricing for risk control But price using projection software do not rely on spreads alone!! Robust conversations with asset managers critical page ING North America Insurance Corporation

11 Pricing MYGAs for IMOs Avoid Jumbos Highly competitive bidding Almost certain to move at window Litigation risk Should have a strategic reason (e.g. brand new product) for even trying Track Experience by IMO and sub channels lapses, mortality, average premium, average age Be alert for churning Be alert for high mortality Be alert for very high average premiums Very high average ages may suggest inappropriate marketing Exceptions always being requested. Try to keep below 2-3% of premium Costly Issue age exceptions with market conduct implications page ING North America Insurance Corporation Pricing MYGAs for IMOs Track record on shock lapses still not fully developed Many contracts badly worded Beware multitudinous offers at renewal Admin issues can easily arise Don t let the IMOs write the contract Partial withdrawals tend not to be as large as possible 3% common even if 5% or even 10% permitted Very, very competitive market. Should have a competitive advantage for being in it: Large block of business allows for economies of scale Outstanding investment department delivers higher yield Corporate structure allows for low cost of capital Risks skewed toward C2, so annuities bring diversification benefits page ING North America Insurance Corporation

12 Pricing ARs for IMOs Safer, simpler product Longer track record Shock lapse inevitable but strong history that it lies in the 25% range; with improvements possible Again, match to be able to supply (short) new money rates at the end of the Surrender Charge period Again, pricing may take into account profits past surrender charge period Allowed to recoup lost profits through lowering non guaranteed elements Possible market conduct issues if product is created to be more profitable than at issue page ING North America Insurance Corporation Pricing ARs for IMOs Managing IMOs Same sort of remarks as before Track experience Expect IMOs to help consumer anti-select Liquidity after SC period over provides policyholder with extra value Thus smaller shock lapses and less danger. Farther into policy s future Rolodex effect lessened But new money rates needed thus ALM remains important. High rate guarantees can devastate profits With high minimums, stochastic pricing essential page ING North America Insurance Corporation

13 General Remarks for IMOs Conferences expected Have a clear strategic vision High value/medium comp High comp/medium value Note: low comp models don t work! Clear vision on service to consumer Clear vision on service to agents Avoid surprising the IMO Lots of TLC High comp fastest way to ramp up sales Many believe high value model more stable page ING North America Insurance Corporation

14 Selling Annuities Through IMO s EIA Pricing and Risk Management Considerations Ghalid Bagus, FSA FIA CFA Financial Risk Management Consultant June 17, 2008 Background Equity Indexed Annuity sales have grown from $0.2 bn in 1995 to $24.5 bn in 2006 In 2007, EIA s accounted for close to 50% of all fixed annuity sales. Distribution tends to be dominated by IMO s and Banks IMO s account for over 50% of total sales Banks account for over 15% of total sales (Sources: 2007 NAVA Fact Book, LIMRA) 2 1

15 Range of products: Pricing consistency between products Potential anti-selection requires consistent pricing between products Example Companies typically offer range of crediting types (Asian monthly-averaging, point-to-point, etc.) Indices (S&P500, NASDAQ100, etc.) Participation levels differ depending on crediting types and underlying indices Ensures profit neutrality between different crediting types and underlying indices 3 Range of products: Pricing consistency within a product Potential anti-selection requires consistent pricing within product Example Company offering an equity sub-account and a fixed sub-account Offers a bonus on first year premiums Cost of equity sub-account option equals 2.3% Minimum credited rate on fixed sub-account is 3.0% Fixed sub-account turned out to be one of the best fixed annuities offered 4 2

16 Range of products: Pricing consistency within a product Product Features Capped product 100% of annual gain up to 6% 100% of monthly-averaged gain up to 7% Participation product 40% of annual gain 60% of monthly-averaged gain Multiple indices Annual gain on the S&P500 up to 6.5% Annual gain on the NASDAQ100 up to 6.0% 5 Compensation: Optimize IMO compensation versus policyholder benefits Available for compensation, expenses and profit Bond Yield Hedge Cost Maximize bond yield without too much risk to the company Duration bets Credit bets Sector bets Minimize hedge expenditure while still providing adequate policyholder benefits 6 3

17 Compensation: Static hedge cost optimization Need to provide adequate notional to get optimal dealer pricing Typically $5m and higher for each option structure to get optimal pricing Possibilities Reduce number of crediting types and underlying indices Accept certain amount of basis risk by cross-hedging Reduce number of issue dates to ensure sufficient notional accumulation 7 Compensation: Dynamic hedge cost optimization Larger EIA writers moving to dynamic hedging Replicate OTC options with liquid futures contracts Goal is to save on the dealer risk and profit loadings Aggregation of entire liability profile should result in more stable Greeks than a single policy making dynamic hedging more feasible 8 4

18 Compensation: Dynamic hedge cost savings 9 Decrements: Product profitability Important feature because of impact on overall product profitability Example Shock lapse of 30% for a 10-year product with IRR of 12% Increasing shock lapse to 60% reduces IRR to 8% Overall lapses will be driven not only by market conditions over time but also by new product innovations 10 5

19 Decrements: Impact on hedging Dynamic hedge notionals can be adjusted on a daily basis as decrements occur Mostly impacts static hedging Options purchased at beginning of year Decrements occur over the course of the year Could incorporate a lapse assumption but may end up being over- or under-hedged at the end of the year Problem exacerbated by the fact that majority of lapse activity in a given year happen within the first quarter after an index credit Indicates the need for a robust lapse modeling system 11 Decrements: Dynamic lapses Goal is to better model policyholder behavior. Prior studies have found that lapse behavior is sensitive to: Line of business (IMO versus tied agent) Qualified/Non-qualified business Age and gender Policy size Competitor participation features offered Index credit in the most recent period Surrender charges Factor In a given year Line of Business IMO policies have lapse rates 25% higher than those for tied agent policies Gender Males have lapse rates 8% higher than those for females Cap Rate Lapse are 10% higher if a competitor cap rate is 1% higher then in the current policy Surrender Charges Lapse rates are 250% higher when there are no surrender charges 12 6

20 Milliman, Inc Financial Risk Management 71 S. Wacker Drive, 31st Floor Chicago, IL Ph: Fx: