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  • Putting the 'New' in Annuities

    December 8, 2011 by Ron Panko

    Panko, Ron

    Variable annuity writers have taken a new step in risk
    management by introducing investment options with hedge assets.

    The financial crisis was a horrible experience for people as they watched their
    asset values fall sharply. But it was also an amazing laboratory for risk
    management by writers of retirement savings products, said Ken Mungan,
    financial risk management practice leader at Milliman.

    “It was exciting for me to see the life insurance industry use that
    opportunity to see how retirement savings products could be created with a
    strong use of risk-management principles and then be proactive in designing new
    products and new manufacturing processes for those products to give a more
    sustainable offering to the market,” Mungan said.

    Milliman’s new contribution is the creation this year of three “protected
    portfolio” funds that are made up of both exchange-traded funds and hedge
    assets.

    Variable annuity writers have added to their risks since 2002 by offering
    guaranteed withdrawal benefits. These benefits have grown into lifetime
    withdrawal benefits, which have been driving VA sales. But when the financial
    crisis struck in 2008 and account values fell steeply, many insurers found
    themselves struggling to hedge those liabilities on their balance sheets. In
    response, many reduced the benefits they offered in new contracts, and writers
    have worked with firms like Milliman to try to contain risks.

    The three new funds, a joint venture of Milliman and ValMark Advisers, are the
    latest development in what Mungan calls a multiyear effort to create a
    “sustainable manufacturing model.” They embed hedging at the
    subaccount level rather than at the policy level, which should reduce
    volatility in account values.

    “The company still provides a guarantee, but now it’s a much less
    stressful offering on the balance sheet of the company, and it provides more
    stable quarterly earnings,” he said. The new funds have also generated
    positive responses from customers and financial advisers, who value risk
    management in the fund options they own, Mungan said.

    ValMark’s investment advisory business manages exchange-traded fund portfolios
    on behalf of life insurance and investment companies, high-net-worth clients
    and collective trusts. It created ETF allocation portfolios in 2002 before
    launching five traditional ETF allocations for the variable insurance world and
    then partnering with Milliman to create the three so-called “protected
    portfolios.”Michael McClary, chief investment officer at ValMark, said
    Milliman thought ETFs were the perfect tool for its risk-management technique
    because they are index-based, and Milliman uses index-based futures contracts
    as its hedging tool.

    “With our portfolios, since every component of our portfolio is an index,
    there is very little hedge breakage,” he said. “They perform very
    close to what we expect. So that’s where the marriage got started. Milliman
    thought we were the perfect partners.”

    ValMark also worked closely with i-Shares, the largest ETF provider in the
    world, to help design the operational component of the funds, McClary said.

    McClary is manager of the funds.

    “We handle the ETF side, and they do what they need to do on the hedging
    side,” he said. “So if there is a large deposit, we’ll be purchasing
    ETFs, and they will be shorting index-based futures contracts based on their
    methodologies and algorithms.”

    Milliman looks at all of the volatility of each of the individual ETFs on a
    custom basis every day, and the volatility measures are up or down based on the
    volatility of the portfolio, said McClary. “So as the market gets more
    volatile, our net long exposure will decrease,” he said. “As
    volatility goes down, our net long exposure will increase.”

    In simple terms, McClary said, ValMark’s traditional strategic allocation
    models are designed to drive on the expressway at a steady 65 miles per hour,
    and Mungan and Milliman dynamically apply the brakes and change lanes with their
    hedging techniques.

    In the third quarter, the S&P 500 Index was down 13. 87%, but the three
    protected portfolios were down less, McClary said.

    The growth fund was down 6.49%, moderate growth was down 5.62%, and the
    balanced portfolio was down 4.45%.

    Early Adopter: Ohio National

    In late June, Ohio National
    Life Insurance Co. became the first variable annuity writer to add these
    portfolios to their lineup.

    They are available to both inforce and new business, said Stephen Murphy,
    senior vice president, capital management. The company plans to introduce a
    product and new features early next year that will be specifically designed
    around the funds and will provide a richer lifetime withdrawal benefit.

    The new funds were compelling to Ohio National because they benefit the insurer
    and are attractive to the consumer, Murphy said. And when Mungan spoke in June
    to the company’s wholesalers, Murphy said the “buzz that Ken’s
    presentation generated was incredible.”

    In the first two months, about $50 million was invested
    voluntarily in the funds, even though no one is required to put money into them
    as this time, he said. That could represent a significant percentage of new VA
    premium flow, Murphy said, “and it was reassuring to us that we made the
    right move.”

    Overall, using the funds will reduce the amount of hedging Ohio National will
    need to do, “and its downside protection is also going to reduce the
    reserve calls and capital calls that these riders can potentially have,”
    Murphy said.

    Other companies have used a variety of ways to reduce account value volatility,
    he said, but those efforts have been at the policy level. “Those methods
    create the risk for policyholders that they can become stranded in nonequities
    because they move your account value out of equities into fixed income,”
    Murphy said. “The question is, can you protect against a downturn and
    still provide a lot of upside potential? All of our analyses have showed us so
    far that Ken has come up with a structure that provides a lot of downside
    protection but still allows you to participate in much of the upside.”

    Advisers Show Interest

    Indeed, a couple of other companies say they have included protectedportfolio
    funds not so much for their own risk-management purposes, but rather to help
    policyholders manage account-value risk. Jefferson National
    Life Insurance Co. is in the process of adding the funds to its Monument
    Advisor variable annuity, and Prudential
    Financial has added them to its variable universal life insurance
    policies.

    Monument Advisor is designed to be a tax-deferred electronic trading platform
    for fee-based advisers to proactively create and manage portfolios for clients.

    The platform allows advisers to easily rebalance and transfer assets, said Laurence
    Greenberg, company president.

    The only guarantee the company offers is an optional return-of-premium death
    benefit.

    “The advisers want to utilize their own strategies rather than pay the
    insurance company to manage portfolio risk through a rider,” he said.
    “They believe they can do that more cost-effectively than employing
    riders.”

    The annuity offers that opportunity through 330 fund options, compared to an
    industry average of about 40, according to Greenberg. It charges a flat fee of $20
    a month regardless of policy size, which Greenberg said averages about $200,000.

    So before adding the funds, Jefferson National already offered a wide variety
    of asset classes, including funds that short stock indexes.

    “It’s a very different take on the role a variable annuity can play with a
    fee-based adviser in terms of managing their clients’ money,” he said.

    Despite the in-fund hedging, the new funds are not more expensive than existing
    funds in the annuity, Greenberg said.

    “To us, it was an opportunity to help advisers offer that strategy,”
    he said. Jefferson National added one of the portfolio-protected funds in May
    and planned to launch the other two in November.

    Greenberg said requests to add the funds came from advisers.

    “We don’t use wholesalers. We have a centralized desk where our people
    talk to advisers every day and get constant feedback. All we do is serve
    fee-based advisers, so it is essential that we understand what they need to be
    successful.”

    Jefferson National launched Monument Advisor in 2006 and expects to have $850
    million to $900 million of assets under management by year-end,
    Greenberg said.

    The insurer works with more than 1,500 advisers and has about 5,000
    policyholders.

    Addition to VUL

    Prudential added portfolio-protected funds at the end of August to its PruLife
    Custom Premiere II and its VUL Protector.

    “Our product area looked into them and thought they added
    diversification,” said Barbara Cooper, chief risk officer
    for Prudential’s individual life insurance business. “We offered them to
    customers because we felt that a subset would like the management style and the
    approach it takes to investing.”

    Cooper said Prudential did not add the funds as a way to manage the death
    benefit liability. The VUL Protector has a no-lapse guarantee, but the issuing
    companies, Pruco Life and Pruco Life of New
    Jersey, cover that risk through reinsurance, Cooper said.

    According to Mungan, the three protected portfolio funds could be especially
    useful for investors who are in or nearing retirement and dependent on taking
    withdrawals from their holdings. If a significant market decline occurs while
    making periodic withdrawals, account values can fall so rapidly that the
    investors may not have enough left to participate meaningfully in rebounding
    prices.

    “Those two events can combine in a very toxic way to deplete the account
    value for the customer,” he said. “So having a protection strategy
    within a customer’s portfolio means that the sequence-of-returns problem is
    largely solved, and it gives them the ability. . .to benefit reasonably from
    recovery in the market.”

    Mungan estimated that some version of the sustainable manufacturing model
    probably represents about half of current variable annuity sales, “and
    it’s growing at such a rapid rate that I believe it will become the primary
    manufacturing process in the VA industry in the relatively near term.”

    Murphy said risk management challenges for annuity writers can be explained by
    the way airlines hedge the costs of fuel.

    “The reason an airline won’t sell you a ticket for five years from now is
    that it can’t hedge fuel costs five years from now,” he said.

    “If we’re going to sell somebody options, which are what we’re selling in
    our riders, and we have no ability to lock in that cost to hedge these things,
    that’s not a sustainable design. So what these risk-levered funds do is allow
    us to put a policy on the books and predict what it will cost us to hedge that
    policy,” Murphy said.

    EARLY ADOPTER: Barbara Cooper, chief risk officer for Prudential
    Financial’s individual life insurance business, said the company in
    August protected portfolio funds to its variable universal life products to
    help policyholders diversify.Key Points* The Trend: Variable annuity writers are showing interest in new investment
    options that actively hedge assets at the subaccount level.

    * The Significance: These protected portfolios’ reduce the risk of large
    account-value declines while still providing upside potential.

    * The Payoff: Insurers will have better control over their balance sheets and
    more satisfied customers.

    “What these risk-levered funds do is allow us to put a policy on the books
    and predict what it will cost us to hedge that policy.”

    – Stepben Murphy, Ohio
    National Life Insurance Co.

    Audio:

    Listen to the entire interview with Ken Mungan at www.ambest.com/audio.

    Learn More

    Ohio National Life Insurance
    Co.

    A.M. Best Company # 6852

    Distribution: Career agents, securities brokerage firms, banks and
    broker/dealers

    Jefferson National Life
    Insurance Co.

    A.M. Best Company # 6475

    Distribution: Fee-based and fee-only financial advisers

    Pruco Life Insurance Co.

    A.M. Best Company # 8240

    Distribution: Career agents, wirehouses, banks, independent financial planners

    For ratings and other financial strength information visit www.ambest.com.

    Copyright:

    (c) 2011
    A.M. Best Company

    Source:

    Proquest
    LLC

    Wordcount:

    1920

    Originally Posted at InsuranceNewsNet on December 7, 2011 by Ron Panko.

    Categories: Industry Articles
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