Asset Liability Management: Identifying and Managing Risk

Chad MyersVice President

Asset Liability Management

Overview▲ Risk management philosophy affects nearly

everything JNL does– Product development– Product pricing– Investment strategy and implementation– Hedging activities

▲ Emphasis on identifying risks and understanding them– JNL doesn’t take risks it can’t properly evaluate– Assumption of risk requires appropriate compensation– Deterministic vs. stochastic approach

Approaches to Risk Management▲ Pricing

▲ Structure

▲ Reinsurance

▲ Diversification

▲ Hedging

Fixed Annuities

▲ JNL’s single largest product line▲ Third largest fixed annuity block in

the U.S.▲ Spread-based ▲ Contractual minimum interest rate is

generally 3%▲ 92% of JNL’s book can be reset annually

JNL Max Plan Rate vs. Market Rates

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Highest Competitor 9 Yr Treasury Max New Money Competitor Average

Fixed Annuity Interest Spread

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Normalized Net Investment Spread Normalized Credited Rate

Variable Annuities

▲ Growing portion of JNL’s retail liabilities▲ Unit-linked deferred annuity contract

– Performance in the underlying funds is passed onto the client

▲ Asset based fees used to cover benefits /expenses

▲ JNL has moved to an unbundled platform

VA Guaranteed Benefits▲ JNL has chosen not to be a leader on guaranteed benefits

– Aggressive benefits not adequately priced in market– Aggressive benefit built on unproven assumptions

▲ GMDB– Main exposure is to 5% annual accumulation– Perspective II offers return of premium

• Other options offered with appropriate charges– Not reinsured due to manageable mortality-based risk

▲ GMIB– Only offered on unbundled basis– Must be elected at extra charge– Requires annuitization after 10 years– Benefit capped at 200% of premium– Reinsured due to uncertainty of utilization

Perspective II Optional Benefits Elected: Year-to-Date September 2002

No optional benefits elected 71,338,166 13%5% Compounded Death Benefit 107,163,001 19%Maximum Anniversary Death Benefit 59,720,935 11%Combination Death Benefit 90,830,651 16%Earnings Max 30,246,358 5%GMIB 145,244,111 26%2% Premium Credit 23,902,163 4%3% Premium Credit 12,957,713 2%4% Premium Credit 238,462,750 42%20% Free Partial 26,691,070 5%5 Year Withdrawal Charge 31,458,968 6%

Year-to-Date Issues September 2002 562,564,441 100%

Benefit Initial Premium Percentage

Equity Index Annuities

▲ Hybrid of variable annuity / fixed annuity▲ Greater of:

– 90% of the premium accumulated at 3% or…– Percentage of the gain in the S&P 500

▲ Simple design, easy to hedge▲ Options bought to cover the equity portion▲ Fixed income invested to provide

minimum guarantee– Spread-based

Life Insurance

▲ Not primary focus over last several years▲ Maintain $5 billion in life insurance liabilities▲ Term and Interest Sensitive Life▲ Mortality on term locked in at time of sale

due to 90% quota share arrangement▲ Interest Sensitive Life pricing has spread

and mortality gains to cover benefits and expenses

Category 12/31/96 6/30/02

Amount % Amount %

Annuities with Book Value Surrender $15,844 64.0% $13,830 33.0%

Annuities with MVA 1,863 7.5% 4,949 11.8%

Equity-Linked Index Annuities 34 0.1% 2,466 5.9%

Other 733 3.0% 1,327 3.2%

Total General Account Annuities $18,474 74.6% $22,572 53.9%

Life Insurance 4,494 18.1% 5,053 12.0%

Institutional Products 1,464 5.9% 9,786 23.4%

Total General Account $24,432 98.6% $37,411 89.3%

Separate Account (VA) 345 1.4% 4,463 10.7%

Total Reserves $24,777 100.0% $41,874 100.0%

Data is consolidated to include Jackson National of New York.

Statutory Reserves – Major Product Categories

JNL Risk Profile

▲ Three main product types– Fixed annuities / Institutional (spread-

based)– Variable annuities (fee-based)– Life insurance (hybrid of spread and

mortality)

JNL Spread Business Basics

▲ JNL issues contracts with initial crediting rates subject to reset

▲ Policies are subject to surrender charges▲ Long-term rate guarantees are further

subject to market value adjustments▲ Assets are invested in a diversified pool of

mostly fixed income assets to earn a spread

Risk Inherent in Spread Lending Businesses

▲ Interest rate risk

▲ Spread risk

▲ Credit risk

▲ Liquidity risk

Interest Rate Risk▲ Rate movements cause changes in the

value of assets and liabilities

▲ Where sensitivities are materially different, rate changes will cause economic gains or losses

▲ Significant rate increases - book value surrenders

▲ Significant rate drops - minimum rate guarantees

JNL Approach to Interest Rate Risk▲ General risk mitigation

– Option adjusted pricing– Surrender charges– Product diversification

▲ Increasing rates– Swaption program– Market value adjustments

▲ Decreasing rates– Product specific investment guidelines– Annual resets on fixed annuities

Spread Risk▲ Profitability depends on

– Ability to achieve pricing spreads

▲ Spreads can be affected by– Reinvestment risk– Embedded options in assets/liabilities– Equity return assumptions– Investment lag– Lost coupon income– Expense variances

JNL Approach to Spread Risk

▲ Focus on annual reset products for fixed annuities

▲ Match assets and liabilities▲ Low exposure to equity/property▲ Risk adjusted return assumptions▲ Strong expense discipline

Credit Risk

▲ At its core the spread-based business relies on a credit arbitrage– Issue contracts based on high credit rating– Invest in lower-rated credits to earn a spread above

issuance cost– Hold adequate capital to allow for risk

▲ The main question is how much risk to take?– Higher-risk assets provide higher spreads, but

increase capital needs and credit risk– Lower-risk assets have lower capital needs and

credit risk but provide lower spreads

JNL Approach to Credit Risk

▲ Balance trade-off between risk and yield▲ Capitalize the company to a level appropriate

for the level of risk ▲ Evaluate all investments net of expected

long-term default cost▲ Rigorous credit evaluation process▲ Well-diversified portfolio▲ JNL establishes policy, PPMA implements

Liquidity Risk

▲ Liabilities provide for varying degrees of liquidity– Medium-term notes, Single Premium Immediate

Annuities – no liquidity– Fixed annuities offer liquidity with varying

surrender penalties▲ Retail policies tend to be “sticky”

– Due to surrender charges and inertia▲ Institutional holders exercise options very efficiently▲ Asset liquidity must reflect potential liability demands

JNL Liquidity Analysis *

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* Ratio of Available Assets to Potential Obligations

JNL Approach to Liquidity Risk

Variable Annuities

▲ Fee-based business▲ Main drivers of profitability are

determined at pricing▲ Earnings variability driven by:

– Equity returns– Guaranteed benefits– Expenses

Life Insurance

▲ Spread and mortality based business▲ Spread component similar to fixed

annuities▲ Mortality component managed through

reinsurance– Lock in mortality assumptions at policy

issue

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Unhedged Hedged

Hedge Analysis

Rate Scenario

Where Does JNL Stand?