Asset Liability Management: Identifying and Managing Risk

1
Asset Liability Management Identifying and
Managing Risk

• Chad Myers
• Vice PresidentAsset Liability Management

2
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 doesnt take risks it cant properly evaluate
• Assumption of risk requires appropriate
  compensation
• Deterministic vs. stochastic approach

3
Approaches to Risk Management

• Pricing
• Structure
• Reinsurance
• Diversification
• Hedging

4
Fixed Annuities

• JNLs single largest product line
• Third largest fixed annuity block in the U.S.
• Spread-based
• Contractual minimum interest rate is generally 3
• 92 of JNLs book can be reset annually

5
JNL Max Plan Rate vs. Market Rates
8.0
7.5
7.0
6.5
(percent)
6.0
5.5
5.0
4.5
4.0
Highest Competitor
9 Yr Treasury
Max New Money
Competitor Average
6
Fixed Annuity Interest Spread
(Net Spread )
(Net Credited Rate )
8.0
8.0
7.0
7.0
6.0
6.0
5.0
5.0
4.0
4.0
3.0
3.0
2.0
2.0
1.0
1.0
0.0
0.0
Nov-
Nov-
Nov-
Nov-
Nov-
Nov-
May-
Sep-
May-
Sep-
May-
Sep-
May-
Sep-
May-
Sep-
May-
Sep-
May-
Jul-96
Jul-97
Jul-98
Jul-99
Jul-00
Jul-01
Jan-96
Mar-96
Jan-97
Mar-97
Jan-98
Mar-98
Jan-99
Mar-99
Jan-00
Mar-00
Jan-01
Mar-01
Jan-02
Mar-02
Normalized Net Investment Spread
Normalized Credited Rate
7
Variable Annuities

• Growing portion of JNLs 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

8
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

9
Perspective II Optional Benefits Elected
Year-to-Date September 2002
Benefit
Initial Premium
Percentage
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
10
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 SP 500
• Simple design, easy to hedge
• Options bought to cover the equity portion
• Fixed income invested to provide minimum
  guarantee
• Spread-based

11
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

12
Statutory Reserves Major Product Categories
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.
13
JNL Risk Profile

• Three main product types
• Fixed annuities / Institutional (spread-based)
• Variable annuities (fee-based)
• Life insurance (hybrid of spread and mortality)

14
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

15
Risk Inherent in Spread Lending Businesses

• Interest rate risk
• Spread risk
• Credit risk
• Liquidity risk

16
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

17
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

18
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

19
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

20
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

21
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

22
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

23
JNL Approach to Liquidity Risk
JNL Liquidity Analysis
Excess liquidity-1 year horizon
Coverage ratio-30 day horizon
Coverage ratio-1 year horizon
Ratio of Available Assets to Potential
Obligations
24
Variable Annuities

• Fee-based business
• Main drivers of profitability are determined at
  pricing
• Earnings variability driven by
• Equity returns
• Guaranteed benefits
• Expenses

25
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

26
Where Does JNL Stand?
Hedge Analysis
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Rate Scenario
Unhedged
Hedged
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