U.S. Life Insurance Industry Landscape A Presentation to Atlanta Actuarial Club by Kim Steiner April 25, 2012 2012 Towers Watson. All rights reserved.
Overview of presentation The financial outlook for the life industry Sales and Product Trends Key Issues Low Interest Rate Environment Equity Volatility VM-20 Q&A 2
U.S. Life Insurance Industry Landscape Financial Outlook 3
FINANCIAL OUTLOOK S&P Insurance Index vs. S&P 500 (2003 2011) Source: Yahoo finance Note: The S&P Insurance Index is a capitalization-weighted index of domestic equities traded on the New York Stock Exchange and NASDAQ. The stocks in the Index are high capitalization stocks representing the insurance sector of the S&P 500 and include both life and P&C insurance companies. Index Components: AFL,ALL,AIG,CB,CINF,CNC,HIG,JP,LNC,LTR,MBI,MET,MTG,PGR,SAFC,STA,TMK,UNM The performance of S&P insurance index relative to S&P 500 has deteriorated over time since 2003 The performance gap, which was approximately 10% throughout 2003-2007, has now increased to approximately 50% in 2011 4
FINANCIAL OUTLOOK Financial Outlook Current overall outlook for life insurance sector remains Stable (according to S&P, as of Nov. 30, 2011) 75% of individual insurers outlooks stable, up from 46% in Nov. 2010 Life insurance stocks remain at depressed valuations due to low interest rates, equity market volatility and sovereign debt crisis* Positive trends affecting the outlook* Strong capitalization Share buybacks Dividends rising Credit losses remain at immaterial levels * Source: Morgan Stanley 5
FINANCIAL OUTLOOK Financial Outlook Negative trends affecting the outlook* Uncertain macro-economic conditions Equity market volatility remains a threat to earnings Low interest rates weighing heavily on earnings prospects Prolonged low interest rates could result in balance sheet impairments DAC write-downs* Rule changes surrounding DAC accounting (EITF 09-G which limits the expenses that can be capitalized in future) Year end DAC write-offs for some companies due to the prevailing economic conditions Regulatory uncertainty* * Source: Morgan Stanley Which institutions will be declared systemically important Possible elimination of the Dividends Received Deduction Reserving methodology (AG 38) 6
FINANCIAL OUTLOOK Comparison of ROE vs. MV/BV curves Note: The curves shown above were obtained using linear regression on market data. The current market is close to (and actually slightly lower than) the bear market but is significantly below the market peak. Current trading multiples are negatively impacted by a number of factors affecting the industry such as: q q Low interest rates Regulatory uncertainty 7
U.S. Life Insurance Industry Landscape Sales and Product Trends 8
SALES AND PRODUCT TRENDS Several consumer/market trends underlie the market Life coverage is at the lowest level in 50 years* Only one-third of Americans are covered by individual life insurance Need for more insurance has risen to 50% of households. But, financial turmoil has pushed immediate plans to purchase down to 25% Consumers desire low-cost life protection such as term or term UL and have deemphasized accumulation products Demographics are changing Baby boomer bulge is nearing retirement age 2007 recorded the highest number of births in U.S. history** The number of dependents (children and elderly) per 100 working age adults is predicted to rise from 67 in 2010 to 74 in 2020 Ethnic population mix is shifting on the strength of immigration to the U.S. *LIMRA 2011 Life Insurance Ownership Study. **US Census Bureau. The Next Four Decades The Older Population in the U.S.: 2010 2050, U.S. Census Bureau, May 2010. 9
SALES AND PRODUCT TRENDS Individual life insurance sales consist of 4 main product types; universal life (UL) is the top selling product Market Share of Individual Life Insurance by Product Type (Percent of Total FY Premium) 18 19 21 22 21 23 22 23 23 23 22 22 27 24 22 21 20 19 17 22 38 23 33 29 28 31 24 24 37 33 28 27 22 35 38 39 39 41 43 27 25 23 23 22 20 16 14 15 15 15 15 38 41 40 28 29 31 7 6 7 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Variable Life Whole Life Universal Life Term 2008 2009 Source: LIMRA International. Based on first-year premium. Results based on policies issued would be significantly different. 2010 2011 3QTD 10
SALES AND PRODUCT TRENDS Overall individual life insurance premium grew five percent in the first nine months of 2011 The biggest driver of individual life insurance growth was Whole Life (WL), whose premium increased 10 percent YTD 3Q 2011 WL is likely benefiting from premium and cash-value guarantees along with lifetime coverage, which are leading concerns for buyers WL is the only product to produce positive growth in each of the past five years UL premium also grew six percent YTD 3Q 2011 Strong indexed UL sales influenced overall UL sales growth Some of the growth was at the expense of Term due to Term UL sales While term remains the most commonly purchased product after WL, its premium continues to decline, down seven percent YTD 3Q 2011 If term UL sales were included with term instead of with UL, term premium would only be down one percent Variable UL (VUL) premium increased 17 percent YTD 3Q 2011 Much of the increase reflects non-traditional sales such as corporate owned life insurance Overall life insurance policy sales have improved two percent YTD 3Q 2011 Policy count has increased in only two years out of the last 25 years Source: LIMRA 11
SALES AND PRODUCT TRENDS Protection-oriented products are big drivers of individual sales; however, there are factors that present challenges for the industry Many of the term and UL with secondary guarantee (ULSG) products sold over the last several years reflected the impact of excess statutory reserve financing transactions in their pricing The continued low interest rate environment has placed downward pressure on profitability, particularly for ULSG Responses by the industry include: Eliminating the sale of the most capital intensive version of some products Increasing premium rates Reducing or de-emphasizing guarantees Re-designing ULSG and term products to be more reserve efficient Regulators increased reserve scrutiny and the NAIC formed a joint working group to address the issues surrounding the reserve requirements under Actuarial Guideline 38. Early this year the group presented a bifurcated solution that will have implications in the industry. 12
SALES AND PRODUCT TRENDS Although protection-oriented products are driving sales, accumulation-type products are gaining traction in the market Successful accumulation products employ a portfolio crediting rate strategy UL: Low new money rates can make it a challenge for new entrants to compete without an existing asset portfolio to subsidize a competitive crediting rate WL: Use portfolio rate such that dividend scales are not reduced Indexed UL (IUL) continues to gain traction Like the indexed annuity space, IUL sales have held up well through the recent challenging economic period Some carriers have had very good success with their first product, even without the bells and whistles offered by the long-time leading carriers This indicates the indexed concept is catching on well with distributors Annual point-to-point caps generally 10-14%; illustrated rates 6%-9% Long Term Care (LTC) accelerated benefit riders are becoming more prevalent and are particularly important in certain distribution channels (e.g., banks) 13
SALES AND PRODUCT TRENDS Important demographic changes will continue to shape demand for investment-oriented life insurance and other financial products Estimated Cumulative Wealth Transfer ($ Billions) $139 $368 $959 $3,203 $6,506 1990 1995 2000 2010 2020 Growth of Highest-Saving Age Group: 45 64 Years ($ Millions) 46.3 61.9 78.5 The increasing inter-generational wealth transfer will enhance long-term demand for estate planning life insurance products (which will ultimately also generate investment dollars)... Some risk due to changes in tax law. Current tax law expected to be revised at the end of 2012...But the aging of the U.S. population will fuel near-term demand for investment-oriented and retirement products at the expense of traditional life insurance products 1990 2000 2010 Source: U.S. Department of Commerce; Bureau of the Census; Bernstein Research; Cornell University; Towers Watson analysis. 14
SALES AND PRODUCT TRENDS Shifting business mix from life insurance to annuities US Life Insurance First Year Net Premiums and Considerations 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 82% 82% 83% 86% 85% 88% 90% 92% 18% 18% 17% 14% 15% 12% 10% 8% 2003 2004 2005 2006 2007 2008 2009 2010 Source: S&P rating services Life Annuities The life industry continues to shift towards a greater proportion of annuity sales in response to increased consumer demands for saving and income oriented products 15
SALES AND PRODUCT TRENDS Variable and fixed annuity sales are moving back up; forecast for total annuity sales to be up roughly 10 percent over 2010 slightly ahead so far, with Q3 YTD sales up 11% over Q3 2010 (+18% Variable, -1% Fixed) Mix of U.S. Annuity Gross Sales Annuity Sales ($billion) 300 1996-2000 2000-2001 2001-2005 2005-2007 2007-2010 Overall CAGR VA = 17.0% (17.2)% 4.8% 16.3% (9.0)% 4.7% CAGR FA = 7.9 35.4.5 (4.5) 4.0 4.8 CAGR Total = 14.1 (2.6) 3.2 9.5 (5.2) 4.7 250 200 150 185.5 71.5 214.6 210.1 218.4 210.5 98.6 81.6 84.4 73.0 230.0 70.0 252.6 66.6 260.6 103.1 229.1 215.0 102.0 75.0 238.0 77.0 182.8 61.9 100 50 112.4 38.9 73.5 114.0 116.0 128.5 134.0 137.5 160.0 186.0 157.5 127.1 140.0 161.0 120.9 0 1996 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Fore cas t 2011 Q3TD Variable annuity sales Fixed and equity indexed annuity sales 1 1 Includes immediate annuity sales ($7.5 billion in 2010, $6.2 billion in 2011 Q3TD) Source: Variable sales 2010 and prior from Towers Watson VALUE Survey ( VALUE ), includes all non-pension variable annuity premiums (first-year and renewal, separate account and fixed account). 2011 VA sales and fixed sales from LIMRA, includes deferred and immediate annuities, EIAs, and MVA (excludes structured settlements). 16
SALES AND PRODUCT TRENDS Recent VA product development trends suggest a new generation of GMXB designs 1800 1600 Risk Management via Product Design: New product trends embedding risk management techniques into the product design. Cost of guarantees lowered; some products able to restore rich features. 1400 1200 1000 Heavy Competition: GMXBs become feature-laden and rich due to competition; also capital markets more favorable 800 600 400 Product De-Risking: During and post-global Financial Crisis (GFC), tremendous focus on de-risking products, increasing prices. 200 = SPX 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 17
U.S. Life Insurance Industry Landscape Key Industry Issues 18
KEY INDUSTRY ISSUES Key Industry Issues There are several key issues currently impacting the life insurance industry including: Low interest rate environment Equity market volatility Regulatory and accounting changes, including VM-20 These issues are driving insurers to take certain actions related to product revisions 19
KEY INDUSTRY ISSUES Low Interest Rate Levels 5-year Treasury Yield (1995 2011) 20-year Treasury Yield (1995 2011) 5 Year treasury yield (% ) 20 Year treasury Yield (%) 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Yield (%) 8 7 6 5 4 3 2 1 0 Treasury yield curve (end of year) Source: http://www.treasury.gov 2002 2005 0.083 0.25 0.5 1 2 3 5 7 10 20 30 Term (in years) 2011 2008 2005 2002 1999 1999 2011 2008 Treasury yield curve has been dropping over the past few years and becoming flatter Current short term yield is close to zero, 30-year bond yield is 3% There is significant uncertainty about the direction of interest rate movements Guidance from the Fed indicates short-term rates will remain close to zero thru 2014 20
KEY INDUSTRY ISSUES Corporate Spreads Financial Bonds vs. Non-financial Bonds Spread (in %) based on 5 year grade A bonds (2003 2011) Spread (in %) based on 20 year grade A bonds (2003 2011) Spreads on financial bonds have generally been wider than the spreads based on the overall bond market since the start of financial crisis Wider spreads on the financial bonds increase the cost of debt for life insurance companies However, spreads on non-financial bonds have been narrower than the spreads based on the overall bond market An investment strategy that is focused on investing in non-financial bonds will provide yields lower than yields from financial bonds in the current economic environment 21
KEY INDUSTRY ISSUES Equity Market Volatility Volatility S&P 500 (1995-2011) 90 80 70 60 50 40 30 20 10 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Volatility has come down from the unprecedented highs experienced in 2008 but has not attained stability Current volatility remains more than three time the volatility experienced during the precrisis era 22
KEY INDUSTRY ISSUES Regulatory/Accounting Outlook A number of changes are in the pipeline and will be implemented in the near future, including: AG 38 modifications/clarifications Future IFRS for insurance contracts and financial instruments Principle based approaches (PBA) for statutory reserves and capital Own Risk and Solvency Assessment (ORSA) Other key development that will affect the operating environment of U.S. life insurers is Solvency II and the modernization of solvency regulation We might see efforts from U.S. regulators to achieve/maintain equivalence 23
Deterministic Reserve A gross premium reserve that uses company investment strategy under a prescribed economic scenario. Present values use discount rates based on projected earned rates. Net Premium Reserve A seriatim, formulaic type reserve may meet tax needs and establish a minimum floor for statutory reserves. Separate calculation for fund vs. nonfunds products. Defaults to current CRVM for some products. VM-20 UPDATE The VM-20 Minimum Reserve is the maximum of three separately calculated component reserves VM-20 is prospective, applying to new business only, with the possible exception of ULSG (still under discussion) VM-20 Minimum Reserve Stochastic Reserve Up to 10,000 from prescribed ESG. Calculate GPVAD for each scenario. Discount rate is 105% of one-year Treasury rate. Stochastic Reserve = CTE (70) of the GPVADs. Exclusion tests can provide relief from having to calculate the deterministic and stochastic reserve. 24
VM-20 UPDATE VM-20 is currently being considered for adoption by the NAIC s Life Actuarial Task Force (LATF) Adoption timeline Revisions to the NAIC Standard Valuation Law completed in 2009 LATF adoption expected in June Other NAIC committees expected to adopt and forward to states in 2012 42+ state legislatures will have to adopt in 2013 and 2014 Earliest effective date of the new valuation manual appears to be 1/1/2015 Findings from the Impact Study Implementing VM-20 has taken companies longer than expected A couple of areas within VM-20 may need to be refined Net Premium Reserve Mortality requirements LATF will likely adopt VM-20 in June before refinements are complete, making it somewhat of a moving target 25
VM-20 UPDATE Potential implications of VM-20 include increased actuarial workload and increased IT requirements Increased workload, especially for ULSG and Term which are more likely to fail the exclusion tests Such companies will likely need to increase staff, develop relevant expertise, expand IT infrastructure and enhance financial modeling capabilities Increased documentation requirements Increased use of prudent estimate assumptions Especially onerous in case of mortality Future mortality improvement not allowed Benefit from more rigorous experience studies Revisit product designs in light of emerging VM-20 requirements Unless VM-20 changes, reserve financing will still be a common solution for Term and ULSG 26
VM-20 UPDATE VM-20 participation summary and product coverage Count of Products Being Tested in VM-20 Impact Study Product Original Count Revised Count* Phase I Submitted Phase II Submitted ULSG 10 10 9 6 UL without SG (UL wo) 5 4 2 2 Term 13 12 12 8 Traditional Whole Life (TWL) 5 5 5 2 Simplified Issue Whole Life (SIWL) 4 3 3 3 Variable Universal Life (VUL) 6 5 4 1 Indexed Universal Life (IUL) 2 0 0 0 Reinsurance companies 3 3 0 0 Total 48 42 35 22 * Revised count reflects participants who had to drop out of the study due to resource issues All values in this presentation include the resubmitted results Indexed Universal Life products are not included in this impact study due to lack of participation No reinsurers submitted results 27
VM-20 UPDATE Minimum reserve winner" by product Credit spread Alternative 1, on a direct basis, for 1 year of business VM-20 Maximum Reserve Component One Year of Issues Alt 1 Except for ULSG and Term 30, the greatest reserve is usually the NPR VM-20 Maximum Reserve Component One Year of Issues Alt 2 The DR only appears in ULSG and Term products with longer LTPs Results were very similar under Alternative 2, on a net basis, and for 5 years of business 28
VM-20 UPDATE Summary impact of VM-20 on 1 year of business Product Per $1,000 s are averages across participants (which varies), weighted by each participant s amount Comparison of VM-20 to CRVM Total Reserves for 5 Years of New Business Overall Impact Direct Written Business VM-20 Alt 1 VM-20 Alt 2 Product Number of Participants CRVM Reserve Average Per $1,000 Reserve Average Per $1,000 Change from CRVM Reserve Average Per $1,000 Change from CRVM Simplified Issue WL 3 36.5 36.5 0% 36.5 0% Traditional WL 5 24.9 24.9 0 24.9 0 ULSG 8 Results shown on an individual company basis only UL without SG 2 116.6 116.7 0 116.7 0 VUL 4 53.9 55.6 3 54.7 1 Term 10 6 4.9 2.7-46 2.7-46 Term 15 3 14.0 6.8-51 5.0-64 Term 20 8 7.4 4.4-41 3.7-50 Term 30 6 8.3 4.7-43 3.7-55 Aggregate Term 6 6.8 4.4-35 4.2-38 Per $1,000 s are averages across participants, weighted equally by participant Some companies ran a separate term model for each LTP ( Term 10, 15, 20 and 30 ), other companies ran one grouped term model for all LTPs ( Aggregate Term ) Three companies provided us with both individual and grouped results 29
VM-20 UPDATE The switch to VM-20 can have a significant impact on reserve levels For ULSG, VM-20 does not usually result in lower reserves as much as had been expected, especially in early durations. In fact, we usually see reserves increasing under VM-20 However NPR usually decreases relative to AG38, thereby increasing tax inefficiency For Term, VM-20 does appear to result in lower reserves most of the time Aggregating term products for purposes of VM-20 results in roughly a 25% decrease in the VM-20 reserve The presence of reinsurance (not including reserve financing arrangements) usually further reduces VM-20 reserve levels Remaining life products often pass the exclusion tests, leaving their reserves unchanged from CRVM 30
Kim Steiner, FSA, MAAA One Alliance Center 3500 Lennox Road Suite 900 Atlanta, GA 30326-4238 T +1 404 365 1853 kim.steiner@ 31