Hedging Variable Annuity Guarantees

in the Current Environment

Actuaries’ Club of Hartford/Springfield

May 17, 2012

Regynald Heurtelou, Vice-President, MetLife ALM

VA Guarantees – Some Basics

2

Hypothetical

Acct Value TIME

HAV

Guarantee Base

Pay-In

Waiting Period

Pay-Out

Clients elect

whichever produces

greatest benefit

VA Guarantees – Some Basics

3

GMDB – Guaranteed Minimum Death Benefit

GMAB – Guaranteed Minimum Accumulation Benefit

GMIB – Guaranteed Minimum Income Benefit

GMWB – Guaranteed Minimum Withdrawal Benefit

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GMxB : Often used as a Common Reference

Examples:

• Equity Level

• Interest Rate Level

• Equity/Rate Volatility

• F/X Level/ Volatility

• Correlations

Examples:

• Policyholder Behavior

• Mortality Improvement

• Operational Failure

• Transaction Costs

• Counterparty Exp.

• Accounting

ￚ Ex: Currency Translation

VA Guarantees Hedging – Risk Sources

Risks we can hedge in the Cap markets

(and choose to)

Risks we can hedge in the Cap markets

(and choose not to)

Risks we can’t hedge in

the Cap Markets

4

VA Riders – Value Drivers of Hedgeable Risk

Interest Rate Volatility

Equity Price Volatility

Interest Rate Level

Equity Price Level

Value of GMxB Rider

(Put Option)

5

VA Hedging: Examples of Products Used

Product Covered Risk Covered Cost

Equity Futures • Equity • Negligible Upfront, Embedded

carry cost, Quarter roll cost

Treasury Futures • Interest Rate • Negligible Upfront, Embedded

carry cost, Quarter roll cost

Interest Rate Swaps Total Rate of Return Swaps

• Interest Rate & Equity • Bid/ask per tenor and type • Carry emerges over time

Equity / Interest Rate Options

• Equity & Interest Rate, Equity & IR Volatility

• High upfront or over time

Interest Rate / Equity Variance Swaps

• Equity& IR Volatility

• No upfront • Carry emerges over time

Hybrids Capital Market Reinsurance

• Combination of market risks and cross-terms

• High upfront or over time

6

7

“Recent” Market Trend -- Equity and Interest Rate

S&P 500

0

800

1600

2400

1/0

6

5/0

6

9/0

6

1/0

7

5/0

7

9/0

7

1/0

8

5/0

8

9/0

8

1/0

9

US Swap 10 Year

0.0%

2.0%

4.0%

6.0%

8.0%

1/0

6

5/0

6

9/0

6

1/0

7

5/0

7

9/0

7

1/0

8

5/0

8

9/0

8

1/0

9

8

“Recent” Market Trend – Volatility and Correlation

S&P vs. USDJPY

Monthly Return Correlation

-0.5

-0.3

-0.1

0.1

0.3

0.5

0.7

0.9

1/06

5/06

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

3yr 5yr 10yr

S&P Implied 10 Year Volatility

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1/0

6

5/0

6

9/0

6

1/0

7

5/0

7

9/0

7

1/0

8

5/0

8

9/0

8

1/0

9

9

“Recent” Market Trend – Correlation Volatility

10 Year Horizon

Monthly Return

-

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1/03 1/04 1/05 1/06 1/07 1/08 1/09Date

Co

rre

latio

n F

acto

r

10 Year Horizon

Monthly Return

(0.2)

(0.1)

-

0.1

1/03 1/04 1/05 1/06 1/07 1/08 1/09

DateC

orr

ela

tio

n F

acto

r

S&P and Topix S&P and USD/JPY

Correlation↑ → Basket volatility↑ → Option value↑

“Recent” Market Trend – F/X and Basis Risk

• Japanese Yen Strengthening vs US Dollar

– US Companies with Japanese Yen Exposure

– Yen Liabilities / Dollar Investments

– Will we see ¥/$ at 100 again?

• Basis Risk

– Always present

– Active Fund Management / Tradable Index Mapping

– Significantly Increased During Crisis

10

“Recent” Trend – Regulators/Rating Agencies

• US and Foreign Regulators

– US Regulators: Solvency Concerns

• Better understanding of business

» Questions on Hedging at any sign of Market Disruption

» SocGen Rogue Trader: Jan 2008

» May 2010 Flash Crash

» Early August 2011 Equity Volatility

– Foreign Regulators Very Cautious

• Rating Agencies

– Need to “Get it Right”

– Active Monitoring with Willingness to “Pull the Trigger”

– More Stringent Requests Every Year

11

“Recent” Trend – Analysts/Investors/Policyholders

• Analysts

– Issuing More Analysis and Reports on VA Writers

– Questions During Earnings Calls

• Investors

– Paulson at Hartford

– Equity Hammered at Any Sign of Trouble

– Perceived or Real

• Policyholders

– Will React with Market and Trust/Distrust a Brand

– Will Lapse policies

• Could be Good or Bad

12

VA Hedging: Reactions

• Increase in Guarantee Charges

– Immediate Reaction: Reflect increase in Hedging Costs

• Product Design Changes

– Good Risk Management: First Step

• Some Product Features are Difficult to Mitigate

– Product De-Risking

• “Feature Creep” Disappeared

• Restriction on Funds

– Limited Movements/Transfers

– Actively Managed Index Fund

– Reduce/Eliminate Foreign Currency Exposure

– Managed Volatility Funds

– CPPI

• Guarantee Based on Market Indicator

13

Reduction in Capital

Markets Exposures

VA Hedging: Reactions

• Start/Increase Hedging Coverage

– When to Start? At any Cost?

– Increase Number of Greeks Covered. How About Cross-Greeks?

• Delta + Gamma + Rho + Vega

• Short Dated Gamma Hedging as Vols Came Down from Market Highs

– Refine (Add) Hedging Indices (Reduce Basis Risk)

– Increase Universe of Hedge Assets Used

• Hedge Against Capital Increases

– Disconnect Between Accounting Bases

• Highlighted at Distribution Tails

• Macro Hedge Programs

• Put-Spread Collars Around Year End

– Need to Monetize Positions with Certain Market Conditions/Liquidity Concerns

• Usage has Reduced Since 2008

14

VA Hedging: Reactions

• Tightening Hedging Guidelines

– Tighter Required Rebalancing Range

– More Frequent Access to Capital Markets

• Transaction Costs?

– Maybe more Flexibility Needed

• Requires Increase in Tolerance with High Volatility Markets

• Active Trader Instead of Program Trades Move with Market Dislocations

• Counterparty Diversification • Reduce Credit Risk Exposure

• Systemic Risk Reduction • Federal Regulator

• Interrelated Parties

• Systemically Significant Financial Institution

15

VA Hedging: Reactions

• Use of Basket Hedges

– Long Term or Rolling Short Term

– Target Overall Tail Risk

• Or Specific Risk: Manager Basis Risk, Credit Risk in U/lying Funds

– Structure with Broker/Dealer

• Costly/Time Consuming

• Traditional Reinsurers Still Out

• Abandon the Market • Place Business in Runoff

– Still Need to Manage/Hedge Closed Block

• Put Business up for Sale

– Find a Buyer

– Realize Current Losses

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