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©2011 Lincoln National CorporationLLA1107-0130
Annuity Risk ManagementStephen Turer FSA, MAAAVice President of Individual Annuity PricingAugust 4, 2011
18th Annual Meeting of the IABA
Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates.
LLA1107-0130
Fort Wayne, INValuationManagement ReportingDefined Contribution Product Management
Radnor & PHL, PACorporate CenterEquity Risk Management
Omaha, NEGroup Protection
Hartford, CTLife/Annuity Product ManagementExecutive Benefits Product Management
Greensboro, NCLife/Annuity Product ManagementProduct Risk and LiabilityValuation
Lincoln’s Actuarial Presence
184 Actuaries
60 Students
LLA1107-0130
3
Annuity Risk Management
• Overview of Products and Market– Product Mix– Description of GLWB– Current Events and Trends
• Macro Risk Management– Company Mix of Business and Strategy
• Micro Risk Management– Case Study on Dynamic Lapse in Variable Annuity– Variable Annuity Hedging Program– Reserves and Surplus
• Question and Answer Session
LLA1107-0130
19%
74%
5%3%
31%
48%
4%4%
13%
4Q 2006 4Q 2010
Total VA Sales = $40.4B38% Elected Living Benefits
Total VA Sales = $37.6B58% Elected Living Benefits
Guaranteed Lifetime Withdrawal Benefit (GLWB)
Guaranteed Minimum Income Benefit (GMIB)
Guaranteed Minimum Accumulation Benefit (GMAB)
Guaranteed Minimum Withdraw Benefit (GMWB)
Hybrid
Source: LIMRA GLB Election Reports
Overview of Products and MarketVariable Annuity Living Benefit Guarantees
LLA1107-0130
0
20,000
40,000
60,000
80,000
100,000
120,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20+
Contract Value
Withdrawal
InsuranceClient Self-
Insures
.Acc
ou
nt
Val
ue
($)
Policy Years
Overview of Products and MarketGuaranteed Lifetime Withdrawal Benefit (GLWB)
• General withdrawal benefit value proposition to clients:– Protect principal against
market loss via withdrawals or death benefit
– Access to account value– Tax-deferred growth
– Guaranteed growth of annual income when not taking withdrawals
– Protected and predictable lifetime income level
LLA1107-0130
Latest Industry Reactions
• Increasing rider charge
• Developing new risk management features
• Asset transfer programs/ risk managed funds
• Increasing rollups & guaranteed income
• Product features based on market condition
• Offering multiple guarantee options
Early Industry Reaction
• Several players exited the business
• Removed products/features
• Reduced rollups & guarantee income
• Increased rider charge
• Tightened investment restrictions
Annual Step-Up
Lifetime GMWB
5% roll-up 7%+ roll-upAge-banding& 10% roll-up
Product De-risking
Product Innovation & Risk Mgmt
Reaction to Financial CrisisImpact on Living Benefits
2005 2006 2007 2008 2009 2010+2004
Overview of Products and MarketIndustry Timeline & Evolution
LLA1107-0130
Initial withdrawal as percent of single premium deposit, Age 60 at issue and starting withdrawal after a 5-year wait
Current Areas of Focus
Maximize guarantee benefits while
limiting market exposure risk
Implementation of asset transfer
programs and risk managed investment
options
Expected areas of development
Protection for long term care needs
thru Hybrid/Combo products
Guarantees tied to interest rates or
market indices
Average Product Richness, May ‘08 – May ‘11
GMxB rider cost
6%
7%
8%
0.6% 0.8% 1.0% 1.2%
Le
ve
l of
min
imu
m g
ua
ran
tee
2008
2009
2011
Overview of Products and MarketProduct Environment Trend
LLA1107-0130
Overview of Products and MarketProduct Environment Trend
Asset Transfer Programs• Reduces downside risk of account value with complex portfolio insurance
mechanisms• Customized and non-discretionary algorithms rebalance asset allocation in response
to the ratio of Account value and Benefit base
Risk Managed Funds• Volatility Targeting
– Maintain a constant realized fund volatility through volatility forecast• CPPI/ Capital Protection
– Dampen loss in market decline
Key Benefits• Appeal to loss averse customers by reducing downside risk• Enhance risk-adjusted return of underlying account value• Reduce expected cost and residual risk of insurer’s hedging
– Potential for higher guarantees and/or lower rider charge
LLA1107-0130
Sales by Channel1 Sales by Product1
LFD550
Wholesalers
8,000AdvisorsLFN
Work Site
5%
23%
8%15%
19%
30%29%
21%
33%
10%
7%
150Group Benefit
WholesalersBankIndependent PlannerWire/ RegionalManaging General AgentsConsultants/Benefit Brokers
Macro Risk ManagementPowerful Distribution Platforms Drive Diverse Mix of Business
Individual LifeMoneyGuardGroup ProtectionVariable AnnuitiesFixed AnnuitiesDefined Contribution
300 Retirement
Focused
1 January 2009 through March 2011 Normalized Sales (Life, MoneyGuard and Group Protection: Paid Annualized Premiums as reported; Annuity/Defined Contribution: at 5% of Deposits)
9
LLA1107-0130
4%7%
50%18%
21%6%8%
41%
13%
32%
0.0
2.0
4.0
6.0
Hedge Assets Hedge Target
Macro Risk ManagementAnnuities: Solid, Consistent Performance due to Connected Product Design, Distribution and Risk Management
Hedge Effectiveness
MGA Wire Bank IP LFN
Sales By Channel
Total 1Q 2011 Sales $2.6 billion
Year ROE1 Deposits (VA)
Market Position (VA)
2007 20% 11.9 #5
2008 7% 10.1 #5
2009 15% 7.2 #5
2010 19% 8.3 #5
1Q11 23% 2.2 NA 6.7%Company E
6.3%Company H6.8%Company D
6.4%Company G7.0%Company C
6.4%Lincoln7.0%Company B
6.6%Company F7.9%Company A
VA Product Guarantees2
($ B
illio
ns)
12/31/08 12/31/10
2008 1Q 2011
1 Excluding goodwill; See Appendix slide Return on Average Stockholders’ Equity – Retirement Solutions2 Initial withdrawal as % of principal, buying at 60 and holding to 65. As of November 2010
10
LLA1107-0130
Micro Risk ManagementProduct Design
Product Innovation and Responsiveness
Retirement Income Security
Operational Effectiveness
Comprehensive Risk Management
Distribution Depth and Breadth
LLA1107-0130
• Policyholder Behavior is managed, but not eliminated, through:– Product design– Conservative actuarial
assumptions– Experience studies– Product Positioning
• Assumptions:– Fund Mapping– LapsesLapses– Mortality– Income Start– Spousal / Beneficiary Continuation
Micro Risk ManagementPolicyholder Behavior in Product Design
In-Force Management
Front End Product Design
Hedge ProgramFinancial Models
PolicyholderBehavior
LLA1107-0130
Micro Risk ManagementPolicyholder Behavior in Product Design
Generation 4Late 2009
& 2010
Generation 22005-2006
Generation 12003-2004
None-lifetime GMWB benefits with either a 5% or 7% Maximum Withdrawal Rate
Lifetime GMWB with and without 5% roll-up
Generation 32007- early
2009Lifetime GMWB with highest roll-up and most generous features
Lifetime GMWB after the financial crisis with scaled back features
Question: Given the difference of GMWB features by generation can one policyholder behavior assumption work for all?
LLA1107-0130
Micro Risk ManagementPolicyholder Behavior in Product Design
• Base Lapse– Vary by surrender charge schedule (CSDC)– Vary by distribution channel (wire, bank, planner, etc)– Vary by ‘income’ vs ‘comfort’ buyer– Vary by age
• Dynamic Lapse Adjustment– Is a multiple applied to the base lapse assumption to
compensate for the fact that the presence of a GMWB feature may change lapse rates
LLA1107-0130
Micro Risk ManagementPolicyholder Behavior in Product Design
• Slope of Dynamic Lapse Assumption– Need to balance conservatism versus the cost to hedging
• One Sided vs. Two Sided– Do lapse only decrease (one sided) or do lapses increase and
decrease (two sided)– Frequency of step-up may influence this decision– Availability of richer features (Gen 1 vs. Gen 3 or Gen 4)
• Parameters for dynamic lapse formula– Account Value– Guarantee Value; PV(GA) vs. (GA)Guarantee Value; PV(GA) vs. (GA)– Qualified vs. Nonqualified– Income vs. Comfort– Demographics (age, gender, …, investment mix)
LLA1107-0130
Guaranteed Amount can equal
– ‘GA’ = Charge basis generally Greater of (deposit or ASU)• Issues with lifetime GWMB (does deposit = lifetime risk?)
– PV(GA) = Present value of future benefits• Question at what discount rate?• Key considerations if using a discount rate:
– How market sensitive are investors?– Does the discount rate relate to reality?– At what market drop will customer adjust lapse experience– Will lapse rate burnout at an ultimate rate or hit 0% on extreme
drops?
Micro Risk ManagementPolicyholder Behavior in Product Design
LLA1107-0130
Micro Risk ManagementPolicyholder Behavior in Product Design
• Chart Basis– 100,000 Deposit– Age 55 – 4,000 MAW– Age 65 – 5,000 MAW– Age 75 – 5,000 MAW– Assume Immediate Income for
Chart Below
– A2000 (no improvement)– Present value of future benefits
divided by 100,000
= PV(GA) / 100,000
Age / Discount
Rate 0% 1% 2% 3% 4% 9%
55 (F)
122% 104% 90% 79% 70% 43%
65 (F)
87% 77% 69% 62% 57% 38%
75 (F) 55% 50% 47% 43% 41% 30%
PV (GA) is the Present Value of the Guaranteed Amount
LLA1107-0130
Micro Risk ManagementPolicyholder Behavior in Product Design
• Female, Age 60, Income at year 10, 5% Roll-up, various investment mixes
• Numbers in the chart are ratios of the 4% discount rate
DiscountRate
Increase in Valuation Premium
4% 0%
3% + 2%
2% + 11%
1% + 15%
0% + 19%
LLA1107-0130
Effectiveness
Cos
t
No Protection
Static Hedging
Delta Hedging
3 Greek Hedging
Full Reinsurance
Micro Risk ManagementVariable Annuity Hedging Program
Managing VA guarantees requires balancing cost and effectiveness
LLA1107-0130
Micro Risk ManagementVariable Annuity Hedging Program
Objective Have sufficient assets to pay claims when the customers account value equals zero.
How Dynamic strategy which uses derivative instruments to match the change in value futures claims less future premiums (Hedge Target)
Subset of Instruments Market () Rate () Volatility ()
Equity Futures Unchanged Unchanged
Interest Rate Futures
Unchanged Unchanged
Puts
LLA1107-0130
Overview of Risk Based Capital
• RBC is held in addition to Stat. Reserves– Total Asset Requirement (TAR)– Company Action Level– Companies normally quote a % of RBC– C1, C2, C3, C4, Covariance
• Annuity Required Capital– C3P2 has stochastic requirement– TAR average of worst 10% scenarios– RBC equal difference TAR minus Stat. Reserve
LLA1107-0130
Disclosure
• This presentation and certain oral statements made on LNC’s behalf may contain information that includes or is a “forward-looking statement” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A forward-looking statement is a statement that does not strictly relate to a historical fact. A forward look statement includes any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like: “believe”, “anticipate”, “expect”, “estimate”, “project”, “will”, “shall” and other words or phrases with similar meaning. LNC claims the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.
•Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements, legislative and regulatory changes and proceedings, changes in interest rates, sudden or prolonged declines in the equity markets, continued economic decline and credit-related illiquidity, deviation in actual experience regarding future persistency, mortality, morbidity, interest rates or equity market returns from Lincoln’s assumptions used in pricing its products, in establishing related insurance reserves, and in the amortization of intangibles that may result in an increase in reserves and a decrease in net income; and changes in general economic or business conditions. These risks and uncertainties, as well others, are described in LNC’s 2008 Form 10-K, Forms 8-K, and other documents filed with the Securities and Exchange Commission. Moreover, LNC operates in a rapidly changing and competitive environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors.
•Further, it is not possible to assess the impact of all risk factors on LNC’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undo reliance on forward-looking statements as a prediction of actual results. In addition, LNC disclaims any obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this presentation.
• Lincoln Financial Group (LFG) is the marketing name for Lincoln National Corporation and its affiliates. Affiliates are separately responsible for their own financial and contractual obligations.
• Insurance products are issued by insurance affiliates of Lincoln Financial Group
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