U.S. Life Insurance Marketplace Trends Key Industry Issues and Competitive Responses February 2013
Introduction This deck provides an overview of the US Life Insurance marketplace including: Key Industry Issues M&A Trends
U.S. Life Insurance Industry Landscape Key Industry Issues 3
KEY INDUSTRY ISSUES Low Interest Rate Levels 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 Source: http://www.treasury.gov Guidance from the Fed indicates short-term rates will remain close to zero thru 2014 4
KEY INDUSTRY ISSUES Recently High and Volatile Corporate Spreads (Based on all Bonds) During and after the recent economic crisis, lower yields have been generally accompanied by higher spreads 5
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 negatively affect 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 6
KEY INDUSTRY ISSUES Equity Market Volatility 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 7
KEY INDUSTRY ISSUES How does the low interest rate environment impact U.S. insurers Investment Segment Product Inforce New Business Portfolio Life Insurance Locked-in liabilities (ULSG, LTC, Term) Life Insurance Resettable (Other UL, Trad WL, IUL) Can t reset L, okay if well matched, but... Lot of money pulls portfolio rate down Spread compression due to minimum guarantee interest rate (MGIR), or equivalent on Trad WL Current prices require significant mean reversion to achieve target profitability MGIR may be too high (also, PH tax issues) New Money Annuities with locked-in liabilities (SPIAs, structured settlement, close-out) Can t reset L, okay if well matched, but... Priced based on matching of A&L. Less attractive prices. Annuities Resettable (SPDA, IA) Spread compression due to MGIR MGIR may be too high NA Variable Annuities with Living Benefit If hedging was not locked-in, now costs more Most companies NB profitability currently under water Of course, there are also non interest related issues occurring as well AG 38 revisions, VA PH behavior 8
KEY INDUSTRY ISSUES What should companies do regarding low interest rates New business Reprice like crazy Increase ULSG and LTC premium rates Reduce MGIR More derisking on VA LB (and interest rate driven, as opposed to equity volatility) In general, move to less locked-in liabilities (but distributors and consumers like guarantees) Inforce Options more limited Examine/revise investment strategy Raise COI rates starting to find more evidence of companies doing that Sell block to somebody else (e.g., one who believes in fast, mean reversion) Exercise options on VA GMXB charges/benefits Restrict renewal premiums/deposits Some actions could encounter legal action 9
KEY INDUSTRY ISSUES Product responses regarding low interest rates The products that are sold in the market depend on both consumer preferences and insurer s willingness to sell them Products sold are also heavily influenced by the distributors, as virtually all life insurance and annuities are sold, not bought Existing economic conditions have led to various trends in consumer preferences Younger generation (age 50 and below) -- prefers low cost protection products such as term; selling products such as WL has become difficult in the current market Older generation (above age 50) -- consists of pre-retirees and retirees who are mostly concerned about retirement People with money to invest are using accumulation products such as deferred annuities The need for retirement income is making withdrawal benefit features (and guaranteed minimum withdrawal benefits) attractive However, due to lack of liquidity, people are still apprehensive about using single premium immediate annuities as an income vehicle 10
KEY INDUSTRY ISSUES Factors that relate to product responses Insurer s ability/willingness to sell products is affected by many factors Reserving regime continued innovation in the market to design products which are less capital intensive Latest example of this is the launch of Term UL which provides benefits similar to term products based on a UL chassis The move to principle based regime ( PBR ) will significantly affect the product design that will be offered in the market The products might need to be redesigned/repriced to remain profitable The need of securitization to remove the reserve redundancy might be altered However, significant aspects of PBR are still not clearly defined Scope for profits: Insurers have stopped selling products with rich guarantees because they can no longer afford it Another emerging trend is the new wave a VA buy-backs (e.g., Aegon, Axa, Hartford), which represents an attempt to deal with distressed margins and/or capital management 11
KEY INDUSTRY ISSUES Guarantees are a big driver of life insurance sales; however, there are factors that present challenges for the industry The continued low interest rate environment has placed downward pressure on profitability, particularly for UL 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 Financing, if available, is much more expensive today Responses by the industry include: Increased premiums Less generous guarantees Withdrawal of unprofitable products Withdrawal from unprofitable sales (such as sales to older issue ages) Acceptance of lower profitability 12
KEY INDUSTRY ISSUES Technology has been a key driver of innovation and may become central to determining future winners and losers Technology is changing the purchasing landscape Consumers interact with products on myriad levels before actual purchase (direct mail, internet reviews, social media endorsements, company website) But, products remain complicated and sales are still closed by agents Handheld underwriting devices are being used for some distribution channels to enable instant policy approvals (e.g., Primerica) Scalability and efficiency of underwriting and administration systems can allow efficient execution of transactions with policyholders as well as with third parties (i.e., reinsurance or acquisition) Legacy systems can prove to be a burden for companies. Replacement of inefficient legacy systems can be extremely costly However, if properly managed, legacy systems can also create opportunities for the company 13
KEY INDUSTRY ISSUES Distribution Innovations The life insurance industry is searching for ways to better reach the middle market and modernize the distribution system Expansion into work-site distribution channel Products are sold at worksites and paid by employees through payroll deduction Both group and individual sales models work best when supported by specialized worksite sales team As the agent population ages and shrinks, companies are further exploring opportunities to leverage the Web to sell products to a broader market Historically it has been difficult to sell life insurance products beyond term insurance over the Web However, it does provide broad access to the underserved middle market and can be used to educate consumers about products and the process, as well as generate leads for agents An increasing number of companies are also using social media sites like Facebook, LinkedIn and YouTube to increase company brand. LIMRA s study, Getting Social: Using Social Media to Support Business Strategies, found social media use climbed by more than 30 percent by life insurers in 2011 14
KEY INDUSTRY ISSUES Regulatory/Accounting Outlook A bifurcated approach to statutory reserve requirements for Universal Life with Secondary Guarantees (AG38) was adopted, and is effective 12/31/2012 Section 8D applies to policies issued between 7/1/2005 and 12/31/2012 Section 8E applies to new policies issued on or after 1/1/2013 The regulatory / reporting changes listed below are in the pipeline, but the estimated implementation timing continues to change: Future IFRS for insurance contracts and financial instruments US GAAP for insurance contracts Principle based approaches (PBA) for statutory reserves and capital Own Risk and Solvency Assessment (ORSA) The modernization of solvency regulation (Solvency II) in the European Union has been delayed and there is a chance that key rules could be rewritten 15
KEY INDUSTRY ISSUES Most of the industry is taking steps to ensure they are ORSA ready Assess existing ERM capabilities What is the company doing already that can be leveraged? Develop draft ORSA Policy statement Identify the goals of the ORSA Establish the initial scope for the ORSA Draft initial ORSA Report template What should be included in the ORSA Report for the company? Initially Subsequently Establish ORSA processes reporting and documentation Roles and responsibilities for conduct Reporting cycles Documentation protocol 16
KEY INDUSTRY ISSUES Outside of industry pressures, insurers are looking to deliver enhanced business performance through ERM ERM Delivers Business Outcomes Risk appetite (used and understood) Avoiding short-term catastrophic losses and avoiding future insolvency Positive risk culture Strategic decisions that take account of risk and capital Assessment of risk profile and a review of the appropriateness of capital Reduce losses resulting from slow reaction to risk events An understanding of the key risk drivers More informed risk taking A system to monitor the regulatory solvency position Better identification of opportunities to profit from taking risks Wider thinking about risk, including both contingency planning and potential risk opportunities Forward-looking identification, monitoring and reporting of risk An assessment of future capital needs Being able to see the combined impact of decisions on key risk, capital and profit metrics all together Better capital planning More efficient use of capital 17
KEY INDUSTRY ISSUES Understanding the views of different stakeholders is key to developing a successful ERM framework Direct Indirect Shareholder (SH) Policyholder (PH) Debtholder (DH) Rating Agencies (RA) Insurance Regulators (IR) Federal Reserve (FR) Primary Objective Total share return Ability to pay claims Ability to pay debt Protection of policyholders (financial strength) and debtholders (debt rating) Protection of policyholders Soundness of financial system Main Proxies Shareholder Value; Earnings Available Capital Available Capital Available Capital Available Capital Available Capital Fundamental questions needing to be answered: What holistic risk metric(s) succinctly measures the threats to the stakeholders objectives? How do we set up processes to calculate, communicate, and act on these risks? 18
U.S. Life Insurance Industry Landscape M&A Trends 19
M&A OVERVIEW A variety of factors have limited M&A transactions for several years, but increased market activity in 2012 may signal further activity The 2009 lull in insurance-related M&A was caused by: Lack of available access to debt Depressed equity values Companies internal focus on asset side of the balance sheet Market volatility and its broad impact on financial services made it a challenge to structure and close transactions There was no desire to be sold/purchased at fire sale prices Through 2011, insurance-related M&A largely remained slow due to the 2011 global P&C catastrophes, European Union economic crisis (e.g., Greece) and low interest rates, among other factors The 2009-2011 environment in most cases has been weighted heavily toward buyers, as sellers were sometimes forced to sell due to economic circumstances or very dissatisfied shareholders 2012 proved to be a robust year for M&A activity in the U.S. life insurance market and there are strong signals that this will continue into 2013 and beyond 20
M&A OVERVIEW Dow Jones Select Insurance Index vs. S&P 500 (2006 2012) Source: Yahoo finance The performance of the Dow Jones Select Insurance Index relative to S&P 500 has deteriorated over time since the beginning of 2006 From the beginning of 2006 to the end of 2012, the insurance index returned nearly 50% less than the broader market index 21
M&A OVERVIEW During the past eight years, some spectacularly large M&A deals have been completed by North American buyers Acquirer Acquired Entity Completion Date Transaction (U.S.$ million) Anthem, Inc. Wellpoint Health Networks, Inc. November 2004 $21,500 St. Paul Companies Travelers Property Casualty Corp. April 2004 17,600 MetLife, Inc. American Life Insurance Company (ALICO) November 2010 * 15,500 Manulife Financial Corp. John Hancock Financial Services April 2004 13,400 MetLife, Inc. Travelers Life & Annuity Co. July 2005 11,900 Point Acquisition LLC PacifiCare Health Systems, Inc. December 2005 9,000 Lincoln National Corp. Jefferson-Pilot Corp. April 2006 8,000 Swiss Reinsurance Co. P&C business of GE Insurance Corp. June 2006 7,500 WellPoint Holding Corp. WellChoice, Inc. December 2005 6,750 Liberty Mutual Group, Inc. Safeco Corp. September 2008 6,230 United Health Group, Inc. Oxford Health Plans, Inc. July 2004 4,800 Tokio Marine Holdings Inc. Philadelphia Consolidated Holding Corp. December 2008 4,700 Prudential Financial, Inc. AIG Subsidiaries (Star/Edison) February 2011 4,200 Alleghany Corporation Transatlantic Holdings March 2012 3,400 Tokio Marine Holdings Inc. Delphi Financial Group, Inc. May 2012 2,700 However, if you eliminate the AIG-related transactions, there are few mega-deals since 2008, as companies concentrate on bolt-on acquisitions and niche transactions *Does not include bank transactions. Source: SNL Insurance M&A Transactions 2004 2012. 22
M&A OVERVIEW There have been a number of transaction announcements during 2012 that relate to U.S. life insurers Athene Group Ltd. agreed to acquire the U.S. life and annuity business of Aviva PLC Guggenheim Partners agreed to acquire the U.S. annuity business of Canadian based Sun Life Financial Inc. Prudential Financial Inc. agreed to acquire The Hartford s individual life insurance business Massachusetts Mutual Life Insurance Co. agreed to acquire The Hartford s retirement businesses Enstar Group Ltd. agreed to acquire HSBC Holdings PLC's U.S. and Canadian closedlife insurance businesses Guggenheim Partners and Security Benefit Life Insurance Co. acquired the U.S. annuity business of Quebec City-based Industrial Alliance Insurance and Financial Services Athene Group Ltd. agreed to acquire Presidential Life Corp. Jackson National acquired the U.S.-based Admin Re business from Swiss Re Modern Woodmen of America acquired Equitable Reserve association Forethought Financial Group Inc. agreed to acquire The Hartford s individual annuity new business capabilities Fidelity Standard Life Insurance Co. acquired the business of Wonder State Life Insurance Co from the Arkansas Guaranty Association Government Employees Health Association acquired Surety Life Insurance Co. from Allstate MetLife agreed to acquire a number of eastern European operations from Aviva including Aviva Czech Life, Aviva Hungary Life, Aviva Romania Life and Aviva Romania Pensions 23
M&A OVERVIEW Summary of 2012 M&A Deals Deal Announced Date Deal Value ($MM) Deal Value/ Book Value (%)* Athene/Aviva 12/21/12 1,550 67.2 Guggenheim/Sun Life 12/17/12 1,350 111.8 Prudential Financial/Hartford 09/27/12 615 - MassMutual/Hartford 09/04/12 400 - Enstar/HSBC 09/06/12 180 29.2 Guggenheim/Industrial Alliance 08/16/12 undisclosed - Athene/Presidential Life 07/12/12 415 119.3 Jackson/Admin Re 05/30/12 621 116.2 Modern Woodmen/Equitable Reserve 05/24/12 undisclosed - Forethought/Hartford 04/13/12 undisclosed - Fidelity Standard/Wonder State 03/31/12 undisclosed - GEHA/Surety 03/12/12 16 130.7 MetLife/Aviva 01/30/12 undisclosed - *Statutory basis, where available. Source: SNL Financial, PitchBook Data, Inc. 24
M&A OVERVIEW Buyer motivations for recent deals General Buyer Perspectives Several of the deals involve distressed properties and/or highly motivated sellers, where the purchase price is significantly below book value, with the opportunity for significant upside Private Equity Perspectives A number of deals are in part motivated by PE firms wanting assets under management, believing they can earn substantially higher investment returns than were achieved with the previous investment philosophy Most deals include some kind of an improved capital positioning (e.g., offshore entities, capital arbitrage regarding investment vehicles) Some deals are motivated in part by tax benefits Insurance Company Perspectives Some insurers have been able to improve diversification and/or grow in areas that have been difficult to achieve through organic means 25
M&A OVERVIEW Seller motivations for recent deals Sellers are looking to exit from non-core businesses either in terms of product types (e.g., The Hartford sales of two businesses, Allstate sale of Surety Life, Sun Life Financial) or regions (e.g., Aviva, Industrial Alliance) Some sales have been designed to improve the risk profile and/or capital positioning of the remaining entity Some sellers have had few other options outside of a sale In certain cases, existing management has maintained a degree of control and continued involvement following the transaction 26
M&A OVERVIEW A few continuing themes may fuel further activity Many deals have included multiple prospective buyers involved in a competitive environment New potential sellers may emerge, emboldened by prior deal results Prospective buyers who were not the winning bidder in a previous deal may have increased motivations and pressure from investors Private Equity firms are expected to continue/expand activities Potential for further activity from firms like Guggenheim and Athene Re, to further build off of their existing platform Athene Re wannabes emerging Some PE firms are seeking run-off blocks and a quick turnaround, while others are considering growth opportunities Some small to medium-sized mutuals are exploring transaction options as potential solutions to existing issues (e.g., Modern Woodmen acquiring fellow mutual Equitable Reserve) There may be selected opportunities for the right partner 27
How would you rate the success of your company s M&A transactions during the last three to five years relative to expectations? All or most of the deals fell below our expectations M&A OVERVIEW Over half of all North American CFO Survey respondents reported that all or most recent M&A transactions met or exceeded expectations 14% 27% All or most of our transactions exceeded expectations Some deals met or exceeded our expectations, and some deals fell below expectations 32% 27% All or most of our transactions met expectations Source: Combination of Towers Watson Life Insurance CFO Survey #29 and Towers Watson P&C Insurance CFO Survey #2. 28
M&A OVERVIEW Impediments to North American life acquisitions, particularly capital issues, appear to have diminished somewhat since 2009 What impediments stand in the way of your company undertaking an acquisition in the near future? General economic conditions/uncertainty 38% 50% Insufficient number of companies/blocks of business at the right size available for sale 38% 32% Too large of a disconnect between buyer and seller views of value and risk 38% 46% Capital issues/cash constraints 29% 77% Lack of management capacity to complete the transaction and integrate the acquisition target 14% 29% Lack of clear vision from senior management regarding types of acquisitions to pursue Regulatory concerns/constraints Poor experience(s) with M&A transactions Rating agency concerns 19% Not available 19% Not available 10% Not available 5% 27% Accounting standards Weak acquisition currency (i.e., depressed stock price) Source: Towers Watson Life Insurance CFO Survey #29. Other 0% Not available 0% Not available 10% 23% Key impediments for 2011 Key impediments for 2009 29
For those transactions that met or exceeded expectations, what were the key success factors? M&A OVERVIEW According to our North American Life CFO Survey, extensive preplanning and comprehensive communication are as important as price paid and other financial factors Conservative margins embedded in price paid 36% Prework with management teams of both entities to work through transition and role issues 36% Comprehensive communication program to keep employees informed and engaged 27% General economic conditions and/or external events 27% Greater revenue or expense synergies than anticipated 27% Thorough and early analysis of cultural compatibility 18% Well-documented integration plan 18% Dedicated integration team and resources with specific expertise in people/culture issues Financial incentives to retain key talent/top producers 9% 9% People-related issues Financial-related issues Source: Towers Watson Life Insurance CFO Survey #29 30