Alternatives to Variable Annuities

Alexander Kling Institut für Finanz- und Aktuarwissenschaften London, May 2012

Helmholtzstraße 22 D-89081 Ulm phone +49 (0) 731/50-31230 fax +49 (0) 731/50-31239 email [email protected]

ifa Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

2

Institut für Finanz- und Aktuarwissenschaften

Introduction – background of today’s product development



Investment guarantees in old-age provision contracts are important 

Sometimes required by the legislator 

E.g. in Germany: occupational pensions and government subsidized policies (so called

Riester-contracts) 

Often requested by clients 

In many countries, market shares of unit-linked (variable) policies declined heavily after recent stock market crash



At the same time, unit-linked policies with investment guarantees have been very successful



Current challenges 

Traditional products facing several problems



Solvency regulations



Increasing Transparency Rules and Regulations

ifa May 2012

Alternatives to VA

3

Institut für Finanz- und Aktuarwissenschaften

Introduction – background of today’s product development



The current capital market situation with low interest rates and high volatilities puts significant pressure on traditional products with long term guarantees



Example 1: „Old“ guarantees “in the money” (example from Germany) Entwicklung des Zinsniveaus 1980 - 2011

2011

2010

2009

2008

2007

2006

2005

2004

2003

0% 2002

0%

2001

1%

2000

1% 1999

2%

1998

2%

1997

3%

1996

3%

1995

4%

1994

4%

1993

5%

1992

5%

1991

6%

1990

6%

1989

7%

1988

7%

1987

8%

1986

8%

1985

9%

1984

9%

1983

10%

1982

10%

1981

11%

1980

11%

Rendite 10jähriger festverzinslicher Staatsanleihen

60% des gleitenden 10-Jahresdurchschnitts Garantiezins für das Neugeschäft

May 2012

Alternatives to VA

4

ifa Institut für Finanz- und Aktuarwissenschaften

Introduction – background of today’s product development



The current capital market situation with low interest rates and high volatilities puts significant pressure for traditional products with long term guarantees



Example 2: Guaranteed surrender values for guarantee products in many markets (e.g.

Germany) 

High volatility of interest rates might cause a significant increase in interest rates in a rather short time period 

Market values of bonds drop



Surrender values are not subject to any „market value adjustment“ (guaranteed surrender values)



High surrender could cause significant problems 

Especially if consumer protection organizations and media advise that under such circumstances policyholders should surrender their policy and invest their money somewhere else

ifa May 2012

Alternatives to VA

5

Institut für Finanz- und Aktuarwissenschaften

Introduction – background of today’s product development

• In many countries „year to year“ cliquet guarantees • Long term guarantees • Market consistent evaluation of insurance liabilities shows the significant value of long term guarantees provided in the past

• Decreasing attractiveness of guarantees for clients • Especially for short terms to maturity, i.e. insured of higher age • At the same time: guarantees are highly demanded in this segment

Consumer protection

Variety of additional challenges

Decreasing technical rates

Solvency II



• Several Examples of misunderstood consumer protection • e.g. Unisex • e.g. guaranteed surrender values • Potential to threaten the whole system

ifa May 2012

Alternatives to VA

6

Institut für Finanz- und Aktuarwissenschaften

Introduction – background of today’s product development New and upcoming transparency rules

New and upcoming transparency rules



• Disclosure of charges • Calculation of Risk return Profiles making chances and risks from a client’s perspective transparent • Calculation of “risk indicators” or risk classes Risikoklasse 2 100% < 0% 0%–2% 2%–5% 5%–8% ≥ 8%

90% 80% 70% 60% 50% 40% 30%

23,9% 23,1%

17,7%

20%

11,8% 7,8%

10% 0,0%

0,0%

0,0%

< -2% -1%

0%

6,9%

3,9%

2,2%

1,3%

0,8%

7%

8%

9%

10% 11% 12% 13% 14% 15% ≥15%

0,3%

0,1%

0,1%

0,0%

0,0%

0,0%

0%

0,0%

May 2012

Alternatives to VA

7

1% 31,7%

2%

3%

4% 52,7%

5%

6%

13,1%

ifa

2,6%

Institut für Finanz- und Aktuarwissenschaften

Introduction – background of today’s product development  

This lead to a variety of products developments of unit-linked products with guarantees In what follows  Overview over the most important concepts besides Variable Annuities

ifa May 2012

Alternatives to VA

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Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

9

Institut für Finanz- und Aktuarwissenschaften

High watermark guaranteed funds

Product design • Family of guaranteed funds (different maturities) with monthly ratchet • Monthly ratchet makes sure that all premiums paid into the fund are guaranteed at maturity • If maturity of the policy is after the maturity of the “longest” fund, client’s money is switched • either immediately when a new fund is offered (which requires the new fund to come with the previous fund’s guarantee) or when the old fund matures. Recent developments • Initially extremely successful in several countries due to very simple marketing • 100% premium guarantee, 100% “highest value guarantee”, up to 100% equity exposure • Not seen as „state-of-the-art“ any more • Risk-return-profiles show the limit in upside-potential • Less new business in this product category Challenges in the current environment • Cash lock risk has become an issue • High volatilities and low interest rates lead to decreasing stock ratios

ifa May 2012

Alternatives to VA

10

Institut für Finanz- und Aktuarwissenschaften

High watermark guaranteed funds 

Why have these funds been developed? 



“Ordinary” guaranteed funds are not suitable for regular premiums 

guarantee = price at inception



when investing a subsequent contribution, NAV might exceed the guarantee  not sufficient for return of premium guarantee

This was solved by the following ratchet guarantee: 

At inception the fund guarantees that the price at maturity will be at least as high as at inception



During the term there is a monthly ratchet-day (pre-specified date)



At any ratchet-day, the guarantee is increased to the current fund level, if the fund exceeds the NAV of all previous ratchet-days,



 Consequence: Any premium which is invested at any ratchet-day is guaranteed at maturity

ifa May 2012

Alternatives to VA

11

Institut für Finanz- und Aktuarwissenschaften

High watermark guaranteed funds 

The funds 

Each fund invests in both, risky and risk-free assets 

permanent re-allocation between the two, depending on the current market situation



path-dependent management (CPPI) 

 cash-lock risk is the largest disadvantage of the concept

ifa May 2012

Alternatives to VA

12

Institut für Finanz- und Aktuarwissenschaften

High watermark guaranteed funds 

Excursion: What is CPPI? split the available capital in a risky and a risk-free investment



guarantee cushion PV of the guarantee

The higher the cushion, the higher the stock ratio. NAV

cash-lock: Risk free rate is needed to provide the guarantee  no future equity participation possible

PV of the guarantee (floor)

t 

T

rather high cash-lock risk  with every new ratchet, the floor is increased due to the ratchet mechanism  PV calculated with “market rate minus fees”

ifa

May 2012

Alternatives to VA

13

Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

14

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products

Product design • Very simple design: “Zero plus underlying” where traditional life insurance with a guaranteed rate of interest is used as the safe asset • Typically: Guarantee = premiums paid • Each premium paid is split in three parts: charges; PV of the guarantee (calculated with the guaranteed rate)  invested in traditional life insurance; Rest  invested in funds • Many different variants of the product exist Recent developments • Rather old concept • Initially very successful, but product was not understood by many distributors and clients • Often marketed like normal unit-linked product without guarantee. If you tick a box, you get a guarantee, that you will get your premiums back. No explanation that ticking the box leads to a significant investment in traditional life insurance • Product’s fund exposure has decreased due to low interest rates • However still sold by many providers Challenges in the current environment • Problems due to low interest rates • For “short term” contracts (sometimes up to 18 years) the product might not be possible any more • Product modifications arise • Same challenges as traditional products  mainly traditional allocation

ifa May 2012

Alternatives to VA

15

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

„Regular“ Hybrid Products 

Mix of traditional and unit-linked insurance



Each contribution is split 

Charges



Cost of insurance (COI)



PV of guarantee (calculated with guaranteed rate) is invested in traditional insurance



The rest is invested in funds

traditional

Fund

Charges

COI

Guarantee

ifa May 2012

Alternatives to VA

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Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

„Regular“ Hybrid Products  This is essentially equivalent to a “zero plus underlying” product  In particular:  The concept is so conservative, that the guarantee can be provided even if fund drops to zero.

Fund 1.75% Charges

traditional

Premium at investment May 2012

Alternatives to VA

maturity

ifa 17

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products Such products are sold as “unit linked plus guarantee” but in reality, the equity exposure is rather small Example: Term 30 years, typical charges, relative mix between unit-linked (yellow) and traditional (red) over time

Jan 35

Jan 33

Jan 31

Jan 29

Jan 27

Jan 25

Jan 23

Jan 35

Jan 21

0%

Jan 19

0%

Jan 17

10%

Jan 15

10%

Jan 05

20%

Jan 33

20%

Jan 31

30%

Jan 29

40%

30%

Jan 27

40%

Jan 25

50%

Jan 23

50%

Jan 21

60%

Jan 19

60%

Jan 17

70%

Jan 15

70%

Jan 13

80%

Jan 11

90%

80%

Jan 09

90%

Jan 07

100%

Jan 05

100%

Jan 13

fund performance = 6%

Jan 11

fund performance = 0%

Jan 09



Jan 07



ifa May 2012

Alternatives to VA

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Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products Such products are sold as “unit linked plus guarantee” but in reality, the equity exposure is rather small





Example: Term 12 years, typical charges, relative mix between unit-linked (yellow) and traditional (red) over time fund performance = 0%

fund performance = 6% 100%

90%

90%

80%

80%

70%

70%

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%

0%

0%

Ja

Ja n

n 05 Ju l0 Ja 5 n 06 Ju l0 Ja 6 n 07 Ju l0 Ja 7 n 08 Ju l0 Ja 8 n 09 Ju l0 Ja 9 n 10 Ju l1 Ja 0 n 11 Ju l1 Ja 1 n 12 Ju l1 Ja 2 n 13 Ju l1 Ja 3 n 14 Ju l1 Ja 4 n 15 Ju l1 Ja 5 n 16 Ju l1 Ja 6 n 17

05 Ju l0 Ja 5 n 06 Ju l0 Ja 6 n 07 Ju l0 Ja 7 n 08 Ju l0 Ja 8 n 09 Ju l0 Ja 9 n 10 Ju l1 Ja 0 n 11 Ju l1 Ja 1 n 12 Ju l1 Ja 2 n 13 Ju l1 Ja 3 n 14 Ju l1 Ja 4 n 15 Ju l1 Ja 5 n 16 Ju l1 Ja 6 n 17

100%

ifa May 2012

Alternatives to VA

19

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Due to the very low fund investments in these products, several improved hybrid products were developed.



In what follows, we explain different versions.



In particular, the last version (dynamic hybrid product) is currently very successful.

ifa May 2012

Alternatives to VA

20

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Version 1: Same as regular hybrid product but use some guaranteed fund

Example: guaranteed fund = ratchet fund, e.g. FlexPension



hybrid product with guaranteed fund

regular hybrid product

Fund Fund

0%

charges

1.75%

1.75% charges

traditional traditional

premium

premium

guarantee

guarantee

ifa May 2012

Alternatives to VA

21

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

In this simple idea, certain features of the fund are not considered:



Example 1: One year ago, money was invested in the fund. In the meantime a new peak has been reached which is now guaranteed. 



This increase in the fund’s guarantee can be used to reduce the amount of money invested in the insurer’s general assets.

Example 2: Money is invested today. The fund’s guarantee exceeds the current NAV 

 This guaranteed performance can be considered  Less money is required in the general assets.



If both effects are considered, the money invested in the general assets will likely be reduced over time.



This product is usually referred to as “2-Topf-Hybridprodukt” (“2-Pot Hybrid Product”)

ifa May 2012

Alternatives to VA

22

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

The „2-Pot Hybrid Product“ 

It may happen that after some time, the guarantee in the fund is sufficient (i.e. no more general assets are needed). 25.000

20.000

15.000

10.000

5.000

konventionelles Sicherungsvermögen

Jan 07

Jan 06

Jan 05

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 92

0

Garantiefonds



Then, the fund‘s guarantee exceeds the required guarantee.



The exceeding part can also be invested in funds without guarantee.  so-called 3-Pot Hybrid Product“

May 2012

Alternatives to VA

23

ifa Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

3-Pot Hybrid Product - Backtest (15-year policy) 

general assets (red), guaranteed fund (dark yellow) and non-guaranteed funds (light yellow)

25.000

20.000

15.000

10.000

5.000

May 2012

Alternatives to VA

24

Jan 07

Jan 05

Jan 04

Jan 03

Jan 02

Jan 01

Garantiefonds

Jan 06

konventionelles Sicherungsvermögen

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 92

0

freie Fonds

ifa Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

3-Pot Hybrid Product - Backtest (15-year policy) 

Disadvantage: Part of the guaranteed fund is not in equity!



Advantage of this concept is „not real“ but can be used in marketing, since the guaranteed fund is usually projected with the same rates as an equity fund! 25.000

20.000

15.000

Large fund exposure of the policy. Low equity exposure of the fund!

10.000

5.000

May 2012

konventionelles Sicherungsvermögen Alternatives to VA

Renten 25

Aktien im Garantiefonds

Jan 07

Jan 06

Jan 05

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 92

0

ifa

freie Fonds

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products

Dynamic Hybrid Products – Product Design • A dynamic hybrid product is an individual CPPI calculated for each client with the insurer’s general assets as riskless asset • However, most insurers can only perform the calculations (and hence trade) once a month. This significantly increases the gap-risk. • Guarantee funds used to cover for gap risk (monthly 80% guarantee reset). Recent developments • Introduced in 2006 by HDI Gerling in the German market. Within a few months, several providers followed. • Currently: More than 20 providers in Germany. About 1 in 3 unit-linked policies sold in Germany is a DHP (source: Towers Watson) • First products are offered (or being developed) in several other countries. • Rather skewed distributions become an issue  Product modifications that deal with that issue Challenges in the current environment • Low interest rates increase pressure on traditional part of the allocation • General assets as “safe haven”  Especially in times of high volatilities may have undesired effects for traditional business.  Product designs that reduce trading intensity and/or frequency are an issue.

ifa May 2012

Alternatives to VA

26

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Dynamic Hybrid Product (client individual CPPI) 

Basic idea: Insurer has the technology to calculate an individual CPPI for each client



However, most insurers can only “act” once a month 



 This increases the gap-risk significantly

Ignoring the gap-risk for a second, a dynamic hybrid product is simply an 

individual CPPI calculated for each client



with the insurer’s general assets as riskless asset

ifa May 2012

Alternatives to VA

27

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Dynamic Hybrid Product 

Example: Assume a worst case in equity of 20% within one period

Worst Case

Fund

Fund

Worst-case policy-NAV at the end of the period >= PV of guarantee (calculated with guaranteed rate)

1.75% p.a. traditional

tradtional today

end of period

ifa May 2012

Alternatives to VA

28

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Dynamic Hybrid Product



Still open: How is the gap-risk managed?



Solution: Dynamic Hybrid Product with a special risky asset 

Risky asset = fund that guarantees to lose no more than 20% per period.

ifa May 2012

Alternatives to VA

29

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Typical fund for this product: 

One open-ended fund



Define a “period” - Usually 1 month; concept with 1 year also offered.



Guarantee of the fund:







NAV (end of period) >= 80% of NAV (beginning of period)



80% is arbitrary but used in all existing concepts.

The fund’s guarantee is usually managed by “mini-CPPI”

Dynamic Hybrid Product is therefore CPPI on CPPI

ifa May 2012

Alternatives to VA

30

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Guarantee in the fund is rather “weak” and therefore cheap 

Scenario 1: fund rises by 10% in first month

100

Guarantee for the end of month 2 is set to 88

110 88



Scenario 2: fund declines by 20% in first month (worst case)

Guarantee for the end of month 2 is set to 64 100 80

64

ifa May 2012

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31

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Major advantage of this product over ratchet funds:



Cash-lock risk in the fund only within one period  At the beginning of each period, the fund “forgets” the history



The “cash-lock risk” within the policy (i.e. allocation in general assets) exists only for “old money” 

never for new clients



never for new premiums of old clients



Furthermore: For 1 € surplus, 5 € can be re-invested in equity.

ifa May 2012

Alternatives to VA

32

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Backtest (15-year policy)

25.000

20.000

15.000

10.000

5.000

konventionelles Sicherungsvermögen

May 2012

Alternatives to VA

33

Garantiefonds

Jan 07

Jan 06

Jan 05

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 92

0

ifa Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products 

Similar idea to „3-Pot hybrid“: 

Whenever no money is left in the general assets, some money can be shifted in funds without guarantee (light yellow). 25.000

20.000

15.000

10.000

5.000

konventionelles Sicherungsvermögen May 2012

Alternatives to VA

34

Garantiefonds

ifa

Jan 07

Jan 06

Jan 05

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 92

0

freie Fonds

Institut für Finanz- und Aktuarwissenschaften

Different types of Hybrid Products

konventionelles Sicherungsvermögen

Garantiefonds

freie Fonds

konventionelles Sicherungsvermögen

Jan 07

Jan 06

Jan 05

Jan 04

Jan 03

Jan 02

Jan 01

Jan 00

Jan 99

Jan 98

Jan 97

Jan 96

Jan 95

Jan 94

Jan 93

Jan 07

0

Jan 06

0

Jan 05

5.000

Jan 04

5.000

Jan 03

10.000

Jan 02

10.000

Jan 01

15.000

Jan 00

15.000

Jan 99

20.000

Jan 98

20.000

Jan 97

25.000

Jan 96

25.000

Jan 95

30.000

Jan 94

30.000

Jan 93

35.000

Jan 92

35.000

Jan 92

Some additional comments - comparison to regular hybrid product  Sample calculation  Comments on sample calculations to follow



freie Fonds

Regular hybrid

Dynamic Hybrid

ifa May 2012

Alternatives to VA

35

Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

36

Institut für Finanz- und Aktuarwissenschaften

iCPPI 

Further iCPPI concepts are also available in the market 

Based on a daily basis without using guaranteed funds



Different risk-less assets used 

iCPPI performed by the insurer using its traditional assets



iCPPI performed by an asset manager or bank using bonds or bond funds

ifa May 2012

Alternatives to VA

37

Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

38

Institut für Finanz- und Aktuarwissenschaften

Structured equity-linked products with guarantees 

sold in tranches 

fixed issue date, fixed time to maturity (of some structured asset)



after maturity of the structured asset, arbitrary funds or certificates may be chosen 

 fixed issue date, flexible time to maturity



single premium is invested into the structured asset (usually certificates)



maturity benefit = maturity value of the certificate 

clearly defined as a function of one or several underlyings 

stock indices, baskets, etc.



including a maturity value guarantee



great variety of different structures possible and in the market



One example follows

ifa May 2012

Alternatives to VA

39

Institut für Finanz- und Aktuarwissenschaften

Structured equity-linked products with guarantees 

Allianz Indexpolice (first tranche) 

time to maturity 12 years (Jun 1st 2006 – May 31st 2018)



benefit = maximum of 

124% of the single premium paid and



the so called “mittlere Kursentwicklung” (“average price development”) of Dow Jones EURO STOXX 50 where average index price



average price development =



The average index price is given by the arithmetic average of the index price at 12 pre-specified annual dates (end of May of each year) 

index price at issue

Annual asianing over the whole term!

ifa May 2012

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40

Institut für Finanz- und Aktuarwissenschaften

Select Products

Product design

• Client can choose every year if he wants his accrued account value to participate in the general assets (surplus participation) of the insurer or in some formula-based participation in some equity index • Client’s surplus is used to purchase option on this index participation • The client’s account value cannot fall within a year Recent developments

• Product has been developed by Allianz in the German market (Allianz IndexSelect) • Awareness of other insurers about the success and capital efficiency • Recently: Two insurers „copied“ the product in Germany • Product sold in Switzerland by AXA Winterthur (Protect Plan) is based on the same idea Challenges in the current environment • Very little exposure to market risk for the insurer • Impact only on the conditions of the index participation • Product proof to be rather “capital efficient”

ifa May 2012

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41

Institut für Finanz- und Aktuarwissenschaften

Select Products 

Equity-linked product with guarantee issued by insurer 





Client can choose every year if he wants to participate in 

a security issued annually (index certificate)



the general assets of the insurer

The value of the index certificate at the end of the year equals 





Gross premium guarantee

Maximum of 

the value of the index certificate at the year’s beginning



the so-called “applicable annual return” 

Addition of monthly returns of the DJ EuroStoxx50, where negative returns fully apply whereas positive returns are capped



The cap is readjusted every year

 The client’s account value cannot fall within a year

Annual decision 

Client can decide whether to participate in the general assets or the issued certificate



Obligatory participation in the general assets 

May 2012

if the portfolio value is less than the guarantee’s present value Alternatives to VA

42

ifa Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

43

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons 

Guarantees … 





The “evolution of guarantee models“ was a key issue in product development of recent years. 

It becomes more and more difficult to assess advantages and disadvantages of different guarantee models.



The question of the most efficient guarantees is key for clients!

Charges … 



are legally prescribed in many areas and demanded by clients.

in insurance policies are under constant scrutiny of press and public.

The “transparent representation of charges“ was a key issue in recent years. 

In spite of legal requirements for transparency, some charges remain hidden, e.g. fund charges and implicit guarantee charges.



The question of the real charges of products is key for clients!

ifa May 2012

Alternatives to VA

44

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons



Illustrations of unit linked policies are still based on constant fund growth 

All funds are projected at the same interest rate, regardless of the level of fund based charges and regardless of the investment strategy of the fund



Problems 

no consideration of fund charges



no consideration of asset allocation within the fund



no consideration of explicit guarantee charges (e.g. prices of crash-put options), while guarantee fees of Variable Annuities are considered



no consideration of implicit guarantee charges (e.g. path-dependent switches)



switches on policy level are underestimated for certain product types



Consequences: false incentives for product development and sales



Currently we observe a trend towards use of risk-return profiles instead of traditional illustrations

ifa May 2012

Alternatives to VA

45

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons



A possible comparison of guarantee products 

1) Start with a stochastic simulation of the capital market 



I.e. produce many (e.g. 10.000) scenarios of share price developments and possible interest rate developments (based on adequate capital market models and assumptions)

2) Determine for each of these 10.000 scenarios the performance of the insurance policy 

E.g. in case of a highest-level guarantee fund 

determine first which shifts between equity and bonds the fund manager performs each day



determine then the fund performance after fund charges



determine then the benefits of the insurance wrapper



3) Analyse the probability distribution of benefits



Such calculations can e.g. be done with tools like ifa-SARA which was used to produce the sample charts in the following.

ifa May 2012

Alternatives to VA

46

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons



Typical results of such analyses 

Determine the full probability distribution  bar chart



The following chart shows the distribution of effective yields on gross premiums paid for a sample unit linked policy with no guarantees: Fondsgebunden ohne Garantie 12%

10%

relative Häufigkeit

8%

6%

4%

negative Beitragsrenditen

Alternatives to VA

20%

über 20%

19%

18%

17%

16%

15%

14%

13%

12%

11%

9%

10%

8%

7%

6%

positive Beitragsrenditen

ifa

Figures produced by ifa-SARA. May 2012

5%

4%

3%

2%

1%

-1%

bis 0%

-2%

-3%

-4%

-5%

-6%

-7%

-8%

-9%

-10%

-11%

-12%

-13%

-14%

bis -15%

2%

47

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons



Typical results of such analyses 

Determine certain characteristic figures like average benefit (expected value), median, quantiles (e.g. 5%/25%/75%/95%), or other figures like the probability that certain minimum levels of returns are not achieved

ifa May 2012

Alternatives to VA

48

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons



The following chart compares products based on illustrative(!) assumptions about charges for policy and funds on “typical“ levels for a long term, regular premium contract (long-term equity yield 9% before charges, 20% volatility): 600,000 500,000 400,000 300,000 200,000 100,000 0 Fondsgebunden ohne Garantie

5% - 95%

Dynamisches Hybrid Produkt (monatlich)

25% - 75%

Statisches Hybrid Produkt

Summe Bruttobeiträge

Alternatives to VA

Mittelwert

Klassisches Produkt

Median

Minimum

ifa

Figures produced by ifa-SARA. May 2012

Höchststandsfonds

49

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons



Comparison with illustration at 9% p.a. of the same products

600,000 500,000 400,000 300,000 200,000 100,000 0 Fondsgebunden ohne Garantie

Dynamisches Hybrid Produkt (monatlich)

5% - 95% Median

Statisches Hybrid Produkt

25% - 75% Minimum

Summe Bruttobeiträge Beispielrechnung 9%

Alternatives to VA

Klassisches Produkt

Mittelwert

ifa

Figures produced by ifa-SARA. May 2012

Höchststandsfonds

50

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons 

Risk-return profiles are communicated (example of MLP in Germany)

ifa May 2012

Alternatives to VA

51

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons 

Support for the broker – this is part of the consultation documentation (example of MLP in Germany)

ifa May 2012

Alternatives to VA

52

Institut für Finanz- und Aktuarwissenschaften

Current trends regarding product comparisons 

Consequences 

We assume that product comparisons will be used in the future that consider all charges and other possible sources that can reduce product yields (e.g. path dependent switches) based on risk-return profiles.



Instead of a product selection based on projected maturity benefits only, the risk profile of clients will be matched with risk-return profiles of products.

ifa May 2012

Alternatives to VA

53

Institut für Finanz- und Aktuarwissenschaften

Agenda



Introduction



Overview over alternative unit-linked guarantee products 

Unit-linked products including guarantee funds



Hybrid products (static and dynamic)



iCPPI solutions



Index-linked products 

Single premium tranche products



Select Products



Comparison of guarantee products



Outlook

ifa May 2012

Alternatives to VA

54

Institut für Finanz- und Aktuarwissenschaften

Outlook





Current challenges for guarantee products 

Low interest rates and high volatilities



Rather high and long term guarantees “in the money”

At the same time 





Demand for high guarantees still existent

Convergence of risk management and product development 

Re-designing of traditional products



De-Risking of Variable Annuities



Re-designing of CPPI structures including dynamic hybrid products

Many product developments of the upcoming years will be driven by risk management

ifa May 2012

Alternatives to VA

55

Institut für Finanz- und Aktuarwissenschaften

The Institute for Finance and Actuarial Sciences



ifa

Thank you for your attention

Institut für Finanz- und Aktuarwissenschaften Helmholtzstraße 22 D-89081 Ulm phone +49 (0) 731/50-31230 fax +49 (0) 731/50-31239 email [email protected]

www.ifa-ulm.de Dr. Alexander Kling +49 (731) 50-31242 [email protected]

ifa May 2012

Alternatives to VA

56

Institut für Finanz- und Aktuarwissenschaften

The Institute for Finance and Actuarial Sciences



ifa Institut für Finanz- und Aktuarwissenschaften Helmholtzstraße 22 D-89081 Ulm phone +49 (0) 731/50-31230 fax +49 (0) 731/50-31239 email [email protected]

www.ifa-ulm.de





May 2012

Alternatives to VA

57

Actuarial consulting 

Development and design of innovative life insurance and pension products



Market entry by foreign insurance companies



Questions at the “intersection” of investment banking and life insurance



Actuarial/Finance-related questions regarding traded life insurance policies



Asset-Liability-Management, DFA and Risk Management



Embedded Value (traditional, EEV, MCEV) and Value Based Management



Solvency II, QIS x and Internal Models



Actuarial consulting in non-life insurance



Actuarial/Finance-related questions in private health insurance



Mergers & Acquisitions



Preparation or actuarial testing of IT-concepts



Applications of data mining methods on insurance data

Actuarial Services 

Major actuarial projects



Migration of insurance contracts



Introduction of new policy administration systems

Project Coordination and Strategic Consulting 

Introduction of new products



Market entries

ifa Institut für Finanz- und Aktuarwissenschaften