2018 ACSW - Inforce management
- 1. © Oliver Wyman Nicholas Carbo, FSA, MAAA NOVEMBER 9, 2018 ACSW Fall Meeting Inforce Management
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- 3. 22© Oliver Wyman In-force books are not compendiums of consistent policies. Rather, they contain different products with different cohorts and small but sometimes material differences in profitability. Taking a systematic approach to review them is therefore essential. – MAXIMISING VALUE FROM THE IN-FORCE BOOK (Armbruster, Erasmus, Kirk, Kotanko) Introduction
- 4. 33© Oliver Wyman Agenda 1 Inforce management overview 2 Dynamics of non-guaranteed elements 3 Exchange offer process 4 NY Regulation 210 5 M&A and reinsurance
- 5. 44© Oliver Wyman Inforce management practices poll 1. Does your organization have one or more teams fully dedicated to inforce management? a. Yes b. No c. Not sure 2. How would you best define your role within your organization? a. Pricing/product development b. Valuation/financial reporting c. Inforce management d. Risk management e. Consultant f. Other Inforce management overview
- 6. 55© Oliver Wyman POTENTIAL OBJECTIVES Increase value - Profitability - Economic value - Growth Manage capital/reserves 1 3 2 4 Minimize risk per unit of exposure Minimize exposure What are we trying to accomplish with inforce management? Inforce management is not solely about profitably running off existing business; the potential for growth opportunities should not be overlooked Inforce management overview
- 7. 66© Oliver Wyman Inforce management can be approached many different ways NGE changes Investments Policy changes Transactions • Dividends • Credited rates • COI rates • Post level term premium rates • FIA features • VA fees 1 • Investment manager change • Change hedge practices • Change ALM targets • Target asset allocation changes 2 • Add/remove policyholder options • Buyout offers (example VA) • Exchange programs • Limit additional premium 3 • Captive arrangements • Financial reinsurance – Partial – Full block • Assume other blocks to get scale 4 Operational • Experience study analysis • Data/information management • Predictive analytics • Admin system conversions • Expense reduction 5 Inforce management overview
- 8. 7© Oliver Wyman 7 Example: Fixed annuity pricing The spread between the crediting rate and investment returns compensates the insurer for defaults and expenses while supporting a profit margin Dynamics of non-guaranteed elements • Insurers invest most assets in a bond portfolio with: − AA-BBB in average credit rating − Duration similar to the surrender charge period • Insurers usually assume that they can earn risk premia • In low rate environments, insurers are pressured to invest in lower quality assets to support crediting rate • Typically include commissions, other acquisition expenses, and maintenance charges • Typically set based on the insurer’s internal profit requirements and pricing guidelines • Subject to the guaranteed minimum rate floor, which is typically ~1% in modern policies • Older business may have floors as high as 5% Simplified breakdown of crediting rates vs. investment returns 0.5% 1.0% 1.7% 4.5% 1.3% 0% 1% 2% 3% 4% 5% Portfolio earned rate Credit default charge Expenses Profit margin required Crediting rate The crediting rate is typically most sensitive to the change in the 7-10 year AA-BBB rated bond yields
- 9. 8© Oliver Wyman 8 Example: Fixed index annuity (“FIA”) cap rates FIAs are essentially a fixed spread product; for a typical FIA, NGE management involves managing the cap It is critical for FIA writers to focus on their effective spread, which is the difference between the net earned rate and the effective option cost Base FIA economics (% of fund value) The option budget is the amount available to purchase index credit hedges Index credit is based on cap / realized market performance Pricing spread is set by the company to achieve profitability targets Solve for cap / crediting feature for option cost to closely match option budget (subject to guarantees) 4.7 2.2 3.5 2.2 2.5 0.0 1.0 2.0 3.0 4.0 5.0 Earned Rate Spread Option Budget Option Cost Credit - = Hedge Gain Dynamics of non-guaranteed elements
- 10. 9© Oliver Wyman 9 Example: Post-level term rate optimization PLT dynamics Applying an across the board rate increase drives away healthy lives, causing a need for a higher rate increase Expected claim costs assuming anti-selective lapses Expected claim costs assuming no lapses Distribution of expected claims (Illustrative) Lower HigherMortality risk Dynamics of non-guaranteed elements
- 11. 1010© Oliver Wyman COI practices poll 1. Has your organization considered changing COI rates on inforce UL business? a. Yes b. No c. Not sure d. Not applicable e. Prefer not to answer 2. Has your organization implemented revised COI rates on inforce UL business? a. Yes b. No c. Not sure d. Not applicable e. Prefer not to answer Dynamics of non-guaranteed elements
- 12. 1111© Oliver Wyman Example: COI revisions on UL Increasing numbers of carriers have been raising COIs in recent years, creating precedents for others to follow The instrument • Large variation in revisions across carriers, with 5% to 50% “typical” • Most COI revisions impact policies issued in 1990s to early 2000s The motivation • Slew of carriers imposing rate changes since 2015 suggests a “momentum” effect − Carriers unwilling to cede relative profitability advantage to peers − Lessens adverse distribution impact (“everyone’s doing it”) The path • Historical revisions have often been insufficient, because carriers did not account for effects such as changes in policyholder behavior (e.g., lapses, premium funding) The goal • Restore profitability of contracts on a prospective basis Dynamics of non-guaranteed elements
- 13. 1212© Oliver Wyman Example: COI revisions on UL It is prudent to take a three-stage approach to understanding the feasibility and impact of changing COIs on inforce UL • Feasibility study • Review documents for any limitations on the ability to take action • Define the class • Assess: – Veracity of the evidence – Reliability of existing models – Sufficiency of data – Completeness of existing studies (with supporting documentation) – Further studies and information that may be needed to support a change in non-guaranteed elements • Perform experience studies to support the revised COIs Determine and implement the new non-guaranteed elements Perform experience studies and demonstrate the need for change Assess the risks: is it worth it?1 2 3 • Develop a methodology to calculate revised COIs • Methodology should be consistent with documented re- determination policy (both internal and ASOP 2) • Changes should result in expected future profits consistent with original pricing expectations • Adequately notify, disclose, and secure internal and external approvals Meticulous planning is essential! Dynamics of non-guaranteed elements
- 14. 1313© Oliver Wyman PBR: Modeling management actions on non-guaranteed elements Modeling changes to the credited rate is the most common, followed by changes to COI rates Dynamics of non-guaranteed elements • Type of management actions for non-guaranteed elements by product category – By product category, select where management actions based on the following non-guaranteed elements apply 23 21 21 15 11 10 6 7 9 10 5 1 3 4 5 7 3 2 5 9 0 5 10 15 20 25 30 35 40 45 50 ULSG UL (non-ULSG) IUL VUL Whole Life Other charges (expenses, M&E, expense component of dividends, etc.) adjust based on adverse experience COI rate (or mortality component of dividend scale), adjust based on change in mortality improvement COI rate (or mortality component of dividend scale), adjust based on change in mortality Credited rate (includes cap rate for IUL and other interest related elements, e.g. dividends), adjust based on earned rate #ofresponsesforcategory
- 15. 14© Oliver Wyman 14 Exchange offer process Process for evaluating and executing exchange offers Set financial objective Evaluate in-force for opportunities Converge on short- list of offer structure Estimate take rates and financial impact Execute, monitor, and post-mortem • Improve portfolio economics • Reduce total funding level • Reduce market risk profile and hedge cost • Reduce actuarial risk – i.e., risk of adverse unlocks • Identify segments of in- force with desirable characteristics for offer, given financial objective – Low economic value – High capital intensity – High market risk – High actuarial risk • Requires nuanced view of policyholder behavior for proper segmentation • Brainstorm options – Buyback – Cancellation for fee refund – Contract conversion or enhancement – Other offers • Evaluate candidate options against: – Financial objectives – Client proposition – Adverse selection cost and risks • Source data to inform take rate estimation – Client surveys – Advisor interviews – Prior experience • Estimate take rates for each critical in-force segment • Estimate total portfolio financial impact • Execute offer – Regulatory filings – Client and advisor communications – Operations • Monitor take rates and client behavior • At completion of offer, conduct post-mortem analysis of take rates for future reference 1 2 3 4 5 Exchange offer process
- 16. 1515© Oliver Wyman Non-guaranteed element means any element within a policy provision other than an exempt policy provision that may be changed at the insurer’s discretion without the consent or request of the policy owner and that affects the policy charges or benefits. Non- guaranteed element includes indeterminate premium policy rates, expense and benefit charge rates, interest crediting rates, cost of insurance rates, and index account parameter, but shall not include elements that are not within the insurer’s discretion... – NEW YORK STATE DEPARTMENT OF FINANCIAL SERVICES 11 NYCRR 48 (INSURANCE REGULATION 210) New York Regulation 210 New York Regulation 210
- 17. 16© Oliver Wyman 16 New York Regulation 210 Mark your calendars May 1 “By May 1 of each year, the insurer shall file... a listing of any adverse change in the current scale of non- guaranteed elements of any existing policy that occurred in the prior calendar year.” 6 years “The insurer shall maintain in its records, for six years after the termination of the last policy subject to the board-approved criteria, the written documentation of the determination of non- guaranteed elements required by this Part.” 120 days “An insurer shall file any adverse change in the current scale of non-guaranteed elements…at least 120 days prior to implementation.” 60 days “An insurer shall provide a disclosure document to a policy owner…at least 60 days prior to any adverse change in the current scale of non-guaranteed elements.” 5 years “The board-approved criteria shall…include a statement of the maximum period, not to exceed five years, between reviews of anticipated experience factors and non- guaranteed elements for reasonableness.” New York Regulation 210
- 18. 1717© Oliver Wyman Major financial deals 2014 – 2018 M&A and reinsurance are popular tools for companies looking to exit specific markets or product lines 2014 2015 2016 2017 2018 M&A and reinsurance Transaction type: IPO M&A greater than $0.5B M&A less than $0.5B
- 19. 1818© Oliver Wyman Key takeaways 1 Inforce management can take many forms 2 Meticulous planning is essential 3 There are a number of regulations and actuarial guidelines/standards governing management actions
- 20. 19© Oliver Wyman 19 Questions
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