Perspectives on Variable Annuities The Rise of Managed Volatility Funds

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1 Perspectives on Variable Annuities The Rise of Managed Volatility Funds Michael Sparrow, VP & CFO Annuity Products ACLI Financial & Investment Roundtable March 3,

2 Crisis left companies with tough choices Exit Market Manage Risk Help Investors Close doors and run-off Attempt sale or reinsurance Offer rider buybacks OR Reduce tail risk Improve pricing Reduce volatility of results Maintain VA WB supply Keep array of assets available Managed volatility fund funds arose as a solution to stay in VA market Next step beyond traditional asset allocation Currently over 400 funds and $200 billion in AUM Market largest in VAs, but beginning to expand to retail Protect against large loss 2

3 How the funds work Basic lever is risky asset weighting, but approaches vary Target fund s volatility to a prescribed level Set an absolute limit on fund s volatility Protect against principal loss Capped Volatility Target Volatility Principal Protection 10 Equity 10 Equity 10 Equity Mix % % 6% 9% 12% 15% 18% Realized Vol 21% 24% 27% Bonds / Cash Bonds / Cash Characteristics Focus on tail protection Realized vol driven Never increases core risk exposure Both tail & upside effects Realized vol driven Overweight equity in low vol environment Both tail & upside effects Considers both vol and gain/loss experience Put-like hedge strategies Outcomes Less severe drops Lower E(return) Easier to explain results Modest resv benefit Less severe drops Can outperform static fund Harder to explain Better resv benefit Can maximize loss protection & resv benefits Very complex strategy Difficult to explain results 3

4 Philosophy matters in solution choice Policyholder Returns across different scenarios and time horizons Cost of fund mgmt Insurance Company Policyholder Insurance Company Risk and volatility Profitability Firms and Advisors Continuity of carrier and products Transparency Firms and Advisors Nationwide s mutual orientation puts a heavy focus on the policyholder outcomes and has guided our solutions accordingly. 4

5 VA liquidity is a critical value element Client s need extends beyond the WB income benefit People needing long term care 1 average 2.5 years in a nursing home and 4.5 years outside a nursing home Median cost 2 of health care in retirement will be $265,000 for a couple retiring at 65 in 2020 Unexpected personal costs (home, car, children) Better approach to risk tolerance Client is okay with 7 equity until things go wrong Can enable higher returns in favorable markets Avoid stress and worry, buy-high sell low behaviors Liquidity matters as much as income protection! 1 Funding Savings Needed for Health Expenses for persons Eligible for Medicare, EBRI, December The Sourcebook for Long-term care information, American Association for Long Term Care Insurance,

6 How far should insurers extend it Hurdles to expanding volatility control to inforce Voluntary adoption is slow process with modest results Change of strategy may require board approval, shareholder vote, or SEC approval Some firms and advisors dislike forced asset move Not the investment my client bought Fund strategy is new and not well understood How do I benchmark performance Decision process How important is risk reduction? How much do results improve? How will this affect firm, advisor, and customer satisfaction? Are we okay with risk of regulatory scrutiny and/or litigation? Many VA insurers have concluded that moving inforce VA assets to volatility control funds makes sense. 6