equity-indexed annuities: a view from 1,000 feet - acswacsw.us/fall05/11 equity indexed annuities -...
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EquityEquity--Indexed Annuities: Indexed Annuities: A View from 1,000 feetA View from 1,000 feet
ACSW Fall MeetingNovember 11, 2005
John A. Adduci, FSA, MAAAActuarial Associate, PolySystems Inc.
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Outline of Today’s Presentation:
• Product Description and Features• Trends in EIA
• Sample Policy – how does it work?
• Statutory Valuation
• GAAP Valuation
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EIA Product DescriptionEIA Product Description
Indexed fund value increases based on stock index (such as S&P 500, Nasdaq, etc.).Attractive to Policyholders because:– Equity Market Participation– Downside Protection– Choice of Options
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EIA FeaturesEIA Features
Option Type – How is the amount credited to the policyholder determined?– Point-to-Point (European)– Average (Asian)– Annual Ratchet– Binary– Monthly Cap
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EIA FeaturesEIA FeaturesWhat are the parameters of your option type?
- Option Term- Participation Rate
- Option Cap- Spread / Margin
- Policy Term
- Guaranteed Minimum Nonforfeiture Value
- ROP Floor
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EIA FeaturesEIA Features
Trends in EIA:– Surrender Charges: Higher levels that last longer
are common, cliffs schedules also common– Commissions: generally 1-2% higher– Day One Bonus: common for recent issues– Guaranteed Participation rate floors / Guaranteed
Cap floors– Hot Topic: will EIA some day need to be
registered?– Sales of EIA have steadily increased – see graph
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Graph from Session 31PD of Val Act Symposium 2005, compliments of D. Patterson
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Example Example –– Annual RatchetAnnual Ratchet
Participation 75%Initial index: 1000Initial deposit: $20,000Guaranteed value: 90% premium with 3% interest
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Example Example –– Annual Ratchet Annual Ratchet ––Year 1Year 1
Participation 75%Initial index: 1000Initial deposit: $20,000Guaranteed value: 90% premium with 3% interest
End of year 1:–Index: 1100–Index credit: $20,000 × (1100/1000 – 1) × 75% = $1,500–Indexed account value: $21,500–Guaranteed minimum value: $20,000 × 90% × 1.03 = $18,540
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Example Example –– Annual Ratchet Year 2Annual Ratchet Year 2
Participation 75%Initial index: 1000Initial deposit: $20,000Guaranteed value: 90% premium with 3% interest
End of year 2:–Index: 900–Index credit: $21,500 × (900/1100 – 1) × 75% = – $2,932–Annual Ratchet indexed account value: $21,500–Guaranteed minimum value: $18,540 × 1.03 = $19,096
End of year 1:–Index: 1100–Index credit: $20,000 × (1100/1000 – 1) × 75% = $1,500–Indexed account value: $21,500–Guaranteed minimum value: $20,000 × 90% × 1.03 = $18,540
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EquityEquity--indexed Annuitiesindexed Annuities
Statutory Valuation
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Actuarial Guideline XXXVActuarial Guideline XXXV
Interprets CARVM for EIAsType 1 methods – rare Type 2 methods – not rare
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Actuarial Guideline XXXVActuarial Guideline XXXV
Interprets CARVM for EIAsType 1 methods– Consistent with CARVM if “hedged as required.”– Predictable reserves – gains/losses offset by
hedges.– Appropriate for spreadsheet valuation.– Onerous reporting requirements.
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Actuarial Guideline XXXVActuarial Guideline XXXV
Interprets CARVM for EIAsType 2 methods– Consistency between assumptions underlying
option market values in reserves and statement value of options owned to support business.
– Volatile reserves.
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Actuarial Guideline XXXV, cont’dActuarial Guideline XXXV, cont’d
Type 1 methods– Enhanced Discounted Intrinsic Method (EDIM)
Type 2 methods– CARVM with Updated Market Values (CARVM
with UMV).– Market Value Reserve Method (MVRM).– Black-Scholes Projection Method (BSPM)
Adaptation of MVRM.
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EquityEquity--Indexed AnnuitiesIndexed Annuities
GAAP Valuation
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GAAP for EIAGAAP for EIA
GAAP Valuation – combination of – FAS 97 (for DAC)– FAS 91 (for Host Contract)– FAS 133 (balance sheet and EGP presentation)
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Authorities…Authorities…
FASB document (FAS133)– Some contracts contain “embedded derivatives”– If not a hedge, must be separated from “host
contract” and accounted for as a derivative.– “…gain or loss shall be recognized currently in
earnings”– Host contract “accounted for as if ED were not
present”
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Authorities…Authorities…
Derivatives Implementation Group (DIG)– “The carrying value assigned to the host contract is the
difference between the proceeds received from the issuance of the hybrid instrument and the fair value of the embedded derivative.”
– HC(0) = Initial Premium – VED(0)
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Authorities…Authorities…
Derivatives Implementation Group (DIG)– “The insurer should ignore any minimum liability
that exceeds the sum of the embedded derivative separately accounted for and the host debt instrument that is accounted for applying the debt model.”
– This rejects the use of a Cash Value floor.
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GAAP for EIAGAAP for EIA
New Terminology– Value of Embedded Derivative (VED)
Actuarial Present Value of expected benefits in excess of guaranteed benefits
– Host Contract (HC)Defined below
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GAAP for EIAGAAP for EIA
Components of Balance Sheet– Assets
Bonds – from cash flow– Premiums less benefits– Less expenses & commissions– Less cost of hedging– Plus hedge maturities
– Fair value of hedge– DAC – to be discussed later– Sales Inducement Asset
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GAAP for EIAGAAP for EIA
Components of Balance Sheet (Cont’d)– Liabilities
Fair Value of Embedded Derivative– Discount excess benefits with interest & persistency
Sales Inducement LiabilityValue of Host Contract...
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GAAP for EIAGAAP for EIA
Components of Balance Sheet (Cont’d)– Liabilities
Value of Host Contract – use FAS 91 technique– At issue, premiums less associated VEDs– Target value: final maturity value– Negative cash flow based on Guaranteed Benefits– Based on pure guarantee, not enhanced guarantee– Calculate Internal Rate of Return (Interest on Host Contract)
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GAAP for EIAGAAP for EIA
Components of Earnings– Revenues
Investment income on bondsRealized Gains on InvestmentsGains on hedge instruments – both realized and unrealizedSurrender Charges
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GAAP for EIAGAAP for EIA
Components of Earnings– Expenses
Interest on Host ContractIncrease in VEDRecurring policy expensesNet amortization of DACAccrual of Persistency Bonus
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GAAP for EIAGAAP for EIA
Components of EGP– Revenues
Earned Interest on Bonds– Base is total GAAP liability less hedge
– Gains on hedgeSame as income statement
– Surrender ChargesSame as income statement
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GAAP for EIAGAAP for EIA
Components of EGP– Expenses
Interest on Host ContractIncrease in VEDRecurring policy expensesThese are all the same as income statement
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GAAP for EIAGAAP for EIA
DAC Calculation (1)– Calculate stream of EGPs– Calculate stream of Acquisition Costs– k = (PV Acq Costs) / (PV EGP)– What is the discount rate? (Your problem…)
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GAAP for EIAGAAP for EIA
DAC Calculation (2)DAC = Start with prior DAC
Plus Interest at Discount RatePlus new acquisition expensesLess Amortization = K × EGPt
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Any Questions?Any Questions?
Thank you!