indexing options and more june 20, 2012 tim hill, fsa, maaa milliman, inc
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Indexing Options and More June 20, 2012 Tim Hill, FSA, MAAA Milliman, Inc. A Historical Look at US FIA Annual Sales. Source: AnnuitySpecs. Full year 2011 FIA Sales Results . Source: AnnuitySpecs. Rate Environment – June 16, 2012. Product Trends. Surrender Charges - PowerPoint PPT PresentationTRANSCRIPT
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Indexing Options and MoreJune 20, 2012Tim Hill, FSA, MAAAMilliman, Inc.
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A Historical Look at US FIA Annual Sales
Source: AnnuitySpecs
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Full year 2011 FIA Sales Results Full year 2011 VA Sales – Top Ten Companies ($ in millions)
12/31/11
Rank
Company 2011 Sales
% Chg. vs. 2010
Q4 11Mkt Share
1 Allianz Life $6,319 -7.8% 19.5%
2 Aviva 4,506 -13.9% 13.9%
3 American Equity 4,371 6.4% 13.5%
4 GAFRI 1,847 115.1% 5.7%
5 North American 1,673 8.4% 5.2%
6 Lincoln National 1,615 -20.3% 5.0%
7 Midland National 1,554 -1.5% 4.8%
8 Jackson National 1,497 -11.0% 4.6%
9 ING 1,361 -23.4% 4.2%
10 Security Benefit 941 New 2.9%
Source: AnnuitySpecs
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Rate Environment – June 16, 2012
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Product Trends Surrender Charges
Over 50% have 10-year SC Over 75% have SC <= 10-years Continued but slowing trend
toward 10 / 10 IIPRC, Florida
Agent Commission Modest trend toward lower
commissions In low rate environment, seems
like there will have to be additional cuts
In Bank annuity space clear trend to trade comp for volume
Bonuses Vast majority of sales include a
bonus Typical bonuses are 5 – 10% Vesting schedules are a typical
way to recoup bonus Portion of bonus might come with
a rider
Average Issue age is 65 unchanged
Qualified percent is unchanged
Average size unchanged
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Product Trends – GLWBs GLWBs
GLWBs are not as prevalent as on the VA side but growing On some products, portion electing GLWB > 95% Overall election likely in the 50 – 60%
Typical Structure Premiums accumulated at a set percent
6% to 8% compound 7% to 10% simple Often for 10 years with one renewal available
Payout factors that are similar to VA side 5.0% to 5.5% at 65
Charge is typically bps of benefit base assessed against AV Challenges
Low interest rate environment Actuarial Guideline 33 Continued need for bonus and comp
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Product Trends – New Indices Current fixed buckets in FIAs between 1.0% and 1.5% Current caps are around 3 to 4% on S&P 500 strategies
Difficult to tell upside story How does a company Blended indices
Blend S&P 500 with a fixed crediting rate Fixed crediting rate might be low to subsidize S&P portion 0% credited interest Floor applied in aggregate Use of spread instead of cap to get more upside
Alternative indices Use a index with lower volatility than S&P 500 Trading off return potential for lower costing option Challenges
Need to be able to buy option, less liquid than S&P Limited number of option sellers No historic experience – Must rely on backcasting
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Option Pricing 101 Four Inputs into the price of an option
Examples assumes a 2% option budget which would be able to buy a 4% cap or a 20% participation rate
Risk-free interest rate Typically the swap curve rate for the maturity of the option
1-yr swap curve on 6/14/2012 was 54 bps Capped strategy
If rate rose to 104 bps, cost of option only increases by a few bps
But, if my option budget increased by 50 bps, could buy 5% cap Participation rate strategy
If rate rose to 104 bps, cost of option only increases by a few bps and pushes participation rate to 19%
But, if my option budget increased by 50 bps, could buy 25% participation rate
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Option Pricing 101 Implied Volatility
Volatility is not just a single number but is a complicated surface 1-yr at-the-money vol in example is 19.26%
Capped strategy If vol cut to 15%, cost of option only decreases by a few bps Still can only offer 4% cap
Participation rate strategy If vol cut to 15%, cost of option cut by 19%, pushing
participation to 25%
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Option Pricing 101 Dividend Rate
Since crediting strategies typically use index without dividend, the dividend rate is an input in the option pricing formula
In example dividend assumed to be 2.0% Capped strategy
If dividend increased to 3%, cost of option decreases by 10 bps allowing cap to increase to 4.25%
Participation rate strategy If dividend increased to 3%, cost of option cut by 5%, pushing
participation to 22%
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Option Pricing 101 Length of Option
The last input into the option pricing formula is length In example assumed 1-year option Capped strategy
If length extended to 2 years, cost of option increases by 11 bps But, since I only have to buy the option every 2 years I have
double the option budget or 4% Can push cap up to 8%
Participation rate strategy If length extended to 2 years, cost of option increased by 55% But, since I only have to buy the option every 2 years I have
double the option budget or 4% Can push participation rate to 25%
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Creating an Uncapped Strategy Suppose wanted to create a, 100% participation, uncapped
crediting strategy with no spread Willing to push crediting length to 5 years
Gives an option budget of 5 times 2% = 10% S&P 500 option would cost around 21.4% Need to find index with lower volatility
Low Vol S&P 500 uses the 100 stocks subset with the lowest vols
Option would cost around 15% Defensive funds
Option could cost around 12% Other possibilities
Blend fund with bond fund or other low correlation fund Blend with a fixed account paying a crediting rate less than
option budget
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Creating an Uncapped Strategy Use of spread
Products that have used a spread have traditional back-casted well S&P 500 has thicker tails (meaning more extreme good and bad
years) than option pricing assumes Getting all of the good years after the first x% Very sensitive to implied volatility
Buying-up the crediting parameter Use of a charge to increase the option budget and increase what is
offered Mixed results to date
Extending option reset period beyond 5-years 12-year S&P 500 option in theory could be uncapped with 100%
participation and no spread Would need to find investment bank to price it.
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Challenges of Using New Indices Backcasting
Most indices that would be considered are based on set formula Substitutions can be found for indices that didn’t exist Third party should be used to do calculation
Marketing Challenges of gaining acceptance versus familiar
Purchasing options Limited sources to buy options Likely best to find a single partner and agree upon parameters
Regulatory Insure that no way index could be manipulated Transparency critical Need to carefully craft marketing materials
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FIA Predictions
Vast majority of sales still through IMOs
Continued attention on GLWBs
Significant activity in new indices
Continued and accelerated attention from Banks and
Wirehouses Partial due to challenges on VA side
Desire to tell income story
Moderated product
Sales likely flat due to low interest rate environment
Progress (hopefully) made on AG 33 issues