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U.S. Annuity Market Dynamics and Regulatory Requirements Lee Covington Senior Vice President and General Counsel Insured Retirement Institute Organisation for Economic Co-operation and Development (OECD) Roundtable on Annuities December 6, 2012 U.S. Annuity Industry Assets Annuity Net Assets in Billions $1,800 $1,622 Net Assets in Billions $1,600 $1,502 $1,400 $1,200 Variable Annuities Net Assets $1,000 $800 $777 $600 $400 $421 $200 $0 Source: Morningstar and LIMRA $675 Fixed Annuities Net Assets U.S. Annuity Industry Sales Industry-Wide Annuity Sales, 2006 to Present $60.0 Doallars in Billions $50.0 $40.0 $30.0 $20.0 $10.0 $0.0 Source: Morningstar and Beacon Research Total Variable Annuity Sales Total Fixed Annuity Sales Consumer Need for Lifetime Income Basic demographics Longer lifespans Shift from defined benefit plans to defined contribution plans Rising health care costs Entitlement risk Diminished confidence Other risks Basic Demographics in the U.S. 79 million Baby Boomers (Ages 50-66) Americans between the ages of 60-64 grew 56% from 2000-2010 from about 10.5 million to more than 16.2 million Baby Boomers control more than $13 trillion in investable assets Source: Report by the Insured Retirement Institute and Cogent Research titled “Baby Boomers and Generation Xers: Are They on Track to Reach Their Retirement Goals?” (August 2012) Longer Lifespans for Americans Life Expectancy at 65 25 Additional Years 20 15 female 10 male 5 0 1940 1960 1980 2000 Year 2011 2020 2040 Source: 2012 Social Security Trustees Report; Period Life Expectancy Historical and Projected Longer Lifespans for Americans Longevity > Life Expectancy 65-year-old male: 30% chance of living to 90 65-year-old female: 42% chance of living to 90 A couple, both aged 65, has a 60% of at least one living to 90; 30% chance of at least one living to 95 Shift from DB Plans to DC Plans 1985: 114,000 private-sector, employer-funded defined benefit (DB) plans 2011: Only 27,000 DB plans remaining Only 19% of U.S. workers today have access to a employer-funded DB plan Workers must save using defined contribution (DC) plans, annuities, and other savings vehicles (tax deferred or taxed) Source: Pension Benefit Guaranty Corp; U.S. Bureau of Labor Statistic’s National Compensation Survey Health Care Costs Rising in the U.S. Rising health care costs: 17% of GDP in 2010; 20% of GDP by 2017 Cumulative health costs and premiums: Healthy 65-year-old male: $369,000 on average Healthy 65-year-old female: $417,000 on average Only 37% of Baby Boomers are confident in covering health costs in retirement Only 24% of Baby Boomers are confident in covering long-term care Entitlement Risk Tremendous uncertainty regarding U.S. government systems for retirement income and medical payments (Social Security and Medicare) Require changes to remain financially viable Changes may reduce cumulative benefits retirees receive Diminished Confidence 62% of Baby Boomers believe their personal financial situation will be the same or worse five years from now 60% of Baby Boomers believe their financial security in retirement will be about the same or worse than their parents Source: Report by the Insured Retirement Institute (IRI) and Cogent Research titled “Boomer Expectations for Retirement 2012: Annual Update on Retirement Preparedness” (April 2012) Other Risks Market risk Inflation risk Excess withdrawal risk Sequence of returns risk Asset allocation risk Tax uncertainty Risk Financial Literacy Across the World New research on financial literacy by: Dr. Annamaria Lusardi The George Washington School of Business Director, Global Center for Financial Literacy Questions added to national surveys in several nations across the world Financial literacy measured by understanding of three financial concepts: Compounding interest Inflation Risk diversification World Financial Literacy Key Findings Financial literacy lowest among young adults, the elderly, and women. Financial literacy is positively correlated to retirement planning and participation in retirement plans. Lack of financial knowledge results in fewer retirement savings. Those who plan for retirement and exhibit forward-looking behaviors, on average, accumulate more wealth. Source: Presentation by Annamaria Lusardi titled “Retirement Planning and Financial Literacy around the World” (April 2012) Importance of Annuities in Retirement Strategy Investors agree that annuities are a critical part of a retirement strategy 55% Annuity Owners 73% 2011 2012 8% Non-Annuity Owners 17% Source: IRI Baby Boomers and Generation Xers (August 2012) Increased Focus on Retirement Income Planning and Annuities 84% of advisors say that they are having more client discussions about retirement income planning 71% of advisors say that they had a client request to purchase an annuity during the last year Source: IRI Baby Boomers and Generation Xers (August 2012) Top Five Reasons to Purchase an Annuity 34% 35% 27% 2011 26% 23% 2012 19% 9% 7% 6% 1% Guaranteed Income Advisor Recommended Tax Deferral Principal Protection Inflation Protection Source: IRI Baby Boomers and Generation Xers (August 2012) Consumer Need and Satisfaction with Annuities 63% of annuity owners agree that market volatility makes them more likely to consider an annuity 90% of annuity owners are somewhat or very satisfied with their annuitybased investments Source: IRI Baby Boomers and Generation Xers (August 2012) Preparedness for Secure Retirement Savings = insufficient 27.8% No retirement savings 21.7% Gen-Xers Baby Boomers 65.7% Less than $100K saved 39.1% Source: IRI Baby Boomers and Generation Xers (August 2012) Insufficient Knowledge of Investing 45.1% Gen-Xers 16.2% 40.8% Baby Boomers "Not very" or "not at all" knowledgeable about investing in securities "Very" or "extremely" knowledgeable about investing in securities 17.3% Source: IRI Baby Boomers and Generation Xers (August 2012) Retirement Planning Behaviors Consulted a financial advisor = no Calculated a retirement savings goal = no 40.7% Gen-Xers 62.5% Have not calculated a savings goal Have not consulted an advisor 51.4% Baby Boomers 52.8% Source: IRI Baby Boomers and Generation Xers (August 2012) Annuities = Good Retirement Plan Baby Boomer annuity owners are more confident and more likely to engage in positive retirement planning behaviors than Baby Boomer non-annuity owners 44.3% Calculated a retirement savings goal 69.6% 34.8% Consulted a financial advisor 73.7% Baby Boomer Non-Anunity Owners Baby Boomer Anunity Owners "Very" or "extremely" confident in retirement 31.0% 53.4% Source: IRI Baby Boomers and Generation Xers (August 2012) Middle Class Use of Annuities – High Confidence Eight in 10 buyers of nonqualified annuity contracts have annual household income of less than $100,000; that includes 64% who earn less than $75,000. Nine in 10 Baby Boomers who own annuities believe that they are doing a good job preparing for retirement. Source: IRI Retirement Preparedness Report (April 2012) Educational and Advocacy Efforts The President’s Middle Class Task Force recommended: “Promoting the availability of annuities and other forms of guaranteed lifetime income, which transform savings into guaranteed future income, reducing the risks that retirees will outlive their savings or that their retirees’ living standards will be eroded by investment losses or inflation.” U.S. Government Policy Initiatives Departments of Labor and Treasury joint initiative to increase access to lifetime income options Lifetime Income Disclosure Act (S.267 and H.R.677) Regulatory Requirements Consumer Protection Life Cycle: Consumer Protections Pre-sale / Point of sale Post-sale Accumulation and withdrawal phases Product is state approved and SEC Updated prospectus delivery registered Quarterly / Annual Statement Agent is authorized to sell (insurance delivery licensing & FINRA registration, if Consumer begins taking annual applicable) income amount from covered asset Agent training requirements account Product marketing material authorized under insurance law and FINRA guidelines State Insurance and FINRA suitability review Prospectus / State Disclosure Annuity Buyer’s Guide, if applicable Delivery of contract / certificate Regulatory Requirements Solvency Protection Life Cycle: Solvency Pre-sale / Point of sale Post-sale Post-sale Accumulation and withdrawal phases Annuity payments phase Insurance company establishes Statutory reserve and investment guidelines and capital requirements for restrictions on the assets to inforce contracts which protection is applied Management of financial pre-sale risks through various Product design and pricing activities, including hedging considers risks and costs programs associated with the product, Management of operational and limits exposure to certain risk through various risks (longevity, behavioral, activities, including and capital markets) pre-sale monitoring and enforcing Insurance company assumes adherence to investment management of financial and guidelines and restrictions operational risks at point of sale Hedge activities cease and hedge assets are released Statutory reserve is released and a fixed immediate annuity reserve is put up Remaining risk in annuity payments phase is primarily longevity risk Capital markets risk associated with interest earned on General Account reserve assets remains Enterprise Risk Management Solvency U.S. Regulatory Solvency Framework Seven principles of regulatory solvency framework Statutory Reserve and Capital Guidance Risks and Risk Management Associated with Guarantees Financial Risk Profile Asset Parameters Enterprise Risk Management Risk Capacity Own Risk & Solvency Assessment (ORSA) U.S. Regulatory Solvency Framework Regulatory oversight of insurer solvency occurs within a comprehensive framework Seven principles of regulatory solvency framework for insurance: Regulatory Reporting, Disclosure, and Transparency Off-site Monitoring and Analysis On-site Risk-focused Examinations Reserves, Capital Adequacy, and Solvency Regulatory Control of Significant, Broad-based Risk-related Transactions/Activities Preventive and Corrective Measures, Including Enforcement Exiting the Market and Receivership U.S. Regulatory Solvency Framework Capital and Reserve Guidance for Variable Annuity Guarantees AG 43 and RBC C-3 Phase II provide for rigorous measurement and certification of reserves and capital Calculations based on Conditional Tail Expectation (CTE) CTE is a statistical measure which provides information about the tail of a distribution. CTE(x) is equal to the average of the worst (100-x)% of results AG 43: Reserve based on CTE 70, the average of worst 30% of scenario results C-3 Phase II: Risk-based capital based on CTE 90, the average of worst 10% of scenario results Stochastic scenarios calibrated to NAIC RBC C-3 Phase II criteria A minimum reserve & capital requirement based on the Standard Scenario, which includes prescribed assumptions for mortality, policyholder behavior, investment returns Hedging can be reflected only if a Clearly Defined Hedging Strategy, certified by a financial officer of the company, is in place; the assumed Effectiveness Factor can be no more than 70% Appointed Actuary opines annually on reserve adequacy and compliance with Actuarial Standards of Practice Enterprise Risk Management Enterprise Risk Management Risk Capacity Own Risk & Solvency Assessment (ORSA) Enterprise Risk Management ERM & Risk Capacity ERM is a framework for strategic decision making, risk management activities and governance Insurers have ERM practices in place to identify, measure, and manage risk exposures across all of their activities The American Academy of Actuaries recommends that insurers issuing variable annuity guarantees have robust ERM practices in place Risk Capacity A key consideration within an insurer’s ERM framework is risk diversification and risk capacity Diversity in business mix provides for offsetting risk exposures “Monoline” enterprises take on significant risk concentration – regulators would have the ability to disallow filings by monoline variable annuity guarantee issuers Enterprise Risk Management Own Risk & Solvency Assessment (ORSA) ORSA is one element of a broader ERM framework ORSA Summary Report will be supported by internal risk management materials and more detailed underlying documentation At a minimum ORSA Summary Report should cover: Description of risk management framework Assessment of risk exposures Group risk capital assessment Prospective solvency assessment Goals: Foster an effective level of ERM at all insurers Provide a group-level perspective on risk and capital