Top Variable Annuity Players
Lots of Opportunities, Lots of Challenges. Looking Ahead at the U.S. Life Insurance Industry Colin Devine C. Devine & Associates October 20, 2013
Key Sections 1.
Industry Outlook – Strong potential
2.
Macro Challenges – Low interest rates, equity market volatility, weak economy, Washington unpredictability!
3.
Sources of Risk – Rising capital requirements, long-tail legacy liabilities, regulatory uncertainty
4.
Variable Annuities – Learning from mistakes
5.
Life Insurance Stocks in 2013 – Stellar recovery
6.
Wrapping Up – Steady quality growth is achievable
10/21/2013
2
1. Industry Outlook – Optimistic Are there growth opportunities out there? Post-retirement offers strong potential – Rising longevity, demise of traditional defined benefit pension plans and an aging population are each key demand drivers for retirement income and protection. Only insurers can guarantee lifetime income– Even a 3% inflation rate requires a doubling of income every 23 years; the average length a person can expect to live beyond age 65. No single solution for 75M retiring boomers – Target client is aged 50-70 and possesses both the affluence and urgency to want to solve their retirement financial security needs. 10/21/2013
3
Mortality - good news/bad news Today a $205K life annuity for a 62-year old costs approx. $3.4M; back in 2006 it was $2.2M – an increase of over 50%!!!!!
10/21/2013
Source: MetLIfe
4
The Faces of Retirement
10/21/2013
5
Product design opportunities Can areas of innovation be found in life insurance? Differentiation required in both design and underwriting – Industry needs to move beyond secondary guarantee Universal Life (UL) and overly generous variable annuities (Vas) with living benefits. Indexed UL may be the answer in life insurance – Sales leapt 35% in 2012 to $1.3B or 13% of total industry production. Traditional UL still strong with sales up about 20% to over $3B. Variable annuities can be attractive – Despite the reduction in living benefits they remain a mainstay within IRA rollovers. Managed risk funds have re-energized non-rider sales. Hybrid/combo – Long-term care and Chronic illness riders on life and annuities are generating strong interest. Provides flexibility (no “use it or lose it”) as well as tax advantages and pricing synergies. 10/21/2013
6
2. Headwinds & tailwinds Are life insurers collateral damage from the Fed’s low rate policy?
Industry in reasonable shape – Capital levels are high, liquidity is solid, financial flexibility is good and profitability is improving, albeit slowly with industry long-term ROE’s likely in the 10-13% range. But how fast could this weaken if interest rates don’t begin to rise? Our Achilles heel is long-term interest rates – Between Aug. 2007 Aug. 2012 yield on 10-year U.S. Govt. bonds fell 310 bps to 1.6%. Current level of 2.65% is well below pricing levels and source of rising strain. Federal Reserve has shown little inclination to begin tightening. How quickly should interest rates rise? – Is this the end of a 30-year fixed income bull market? What if it’s not? Low rates putting pressure on long-tailed liabilities; most notably those that relied on aggressive lapse support. But higher rates can bring disintermediation. 10/21/2013
7
Interest rates and credit spreads Federal Reserve’s recent comments suggest no change to current interest rate policy is imminent. 10 Yr. UST
YE 11 YE 12 3Q13 1.89% 1.78% 2.64%
What spread levels are fair value for credit risk on investment grade and high yield debt? What asset classes represent attractive values? Where can you find desirable long duration investments? 8
Investment quality still very solid How much strain are portfolios under from low rates?
General account portfolio growth has been steady – Between 20022012 growth in general account assets rose at a CAGR of 5.5% while policy reserves increased at 5.9%. New investments clearly a challenge with general account yields falling 15-25bps annually. Credit risk has been stable – Since 2002, high yield bonds have held steady at around 5% of total investments and 33% of shareholders equity (ex. OCI). Commercial mortgage arrears have stayed negligible. Have we been taking enough investment risk? Investment losses have been modest – Most portfolios weathered the financial crisis relatively well; particularly vs. banks. Credit losses remain benign in the 20-30 bps range. Tighter spreads and better market liquidity in 2012 gave an opportunity to “cull” weaker credits. 10/21/2013
9
Investment Mix vs. Liabilities
10/21/2013
Source: Company reports
10
Investment quality
10/21/2013
Source: Company Reports
11
3. Key sources of uncertainty What types of risks pose the greatest challenges and what can be done?
Regulatory flux – The role of the Federal Insurance Office is still not clear. PRU and AIG designated as global SIFIs and MET will likely join them. State regulation also undergoing change with principal based reserving, rising capital needs and focus on captive reinsurance. Capital – Risk Based Capital ratios have steadily risen with most insurers above 400% or “AA”. Suggests overcapitalization, but alternative models such as Solvency II in Europe, Treasury stress tests and International Financial Report Standards (IFRS) pose new challenges. Pricing mistakes are immortal – Long-tailed liabilities such as variable annuities (VAs), secondary guarantee universal life (SGUL) and longterm care (LTC) could depress the returns of many insurers for decades to come. Finding investments for this is a challenge. 10/21/2013
12
Risk Based Capital (RBC) ratios Where have Private Equity groups been managing RBC?
10/21/2013
13
Stress test balance sheet leverage Treasury’s assessment of life insurers’ leverage includes general and separate account assets – but not all separate accounts have the same risk Estimated Tier 1 Leverage Ratio of Stock and Mutuals at YE12 Est. Tier 1 Capital to General Account Assets
18.0%
Est. Tier 1 Capital to Total Assets 16.0%
Of Principal’s $119B of separate accounts at 09/30/13, less than $7B were VAs
14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0%
10/21/2013
Na tio nw O hi id o e N at M io n as a sM l ut Pa ual cif Ne ic L if e w Yo No rk Li rt h w fe es te rn Ba nk J.P of A .M m or eric ga a n Ch as W e el ls Fa rg o
To r
AI G ch m ar k Un u St m an co Th r e Ha p rt fo Pr rd in ci pa Af lF la Ge i nw na c n ci Am ort al h Fi er n ip ris anc e Fi ial n Vo an cia ya l -I NG Lin co Me U. S . tL ln if e N a , t Pr I u d io n a n c . en lC t o Pr ial F rp. ot ec inan t iv cia e l Li fe Co rp .
0.0%
Source: Company Reports
14
4. Variable annuities Why are so many insurers pulling back or leaving this business?
What went wrong? – Insurers quick to provide increasingly generous living benefits but slow to recognize they were assuming increased risks as purchaser profile changed. Non-living benefit products are making a resurgence which may suggest appeal of tax deferral. Shift in buyer profile – Increased use of tax-qualified funds, rising age of policyholders and growing use of living benefits confirms trend to use them to provide retirement income. Required minimum distributions (RMDs) from VAs inside RIA’s a growing issue. Product de-risking – Actions taken by insurers include: shift to index funds of existing investments; policy buyouts; higher fees; restrictions on contributions to existing contracts; benefit reductions such as lower withdrawal rates and step-ups; and asset transfer programs. 10/21/2013
15
Managed Volatility Has the financial crisis fundamentally changed investor’s risk tolerance?
An emerging asset class – Can provide a “win-win” for policyholders and insurers as both benefit from a smoother ride. Originally a living benefit de-risking strategy, but it may have broader appeal as an investment option in non-rider VAs, 401(k) plans, and mutual funds. Characteristics – Managed risk funds typically include risk management objectives for volatility, capital protection and fixed income duration. At YE 2012 there were around 118 funds with $87.5B in AUM. Estimate these levels are up over 35% in 2013. Beneficial for policyholders – Produces more stable account values and higher liquidity during periods of equity turmoil. Also reduces "sequence of returns” that those taking systematic withdrawals will exhaust their account balance. 10/21/2013
16
Over time equity markets have risen… In general investing in the equity market has been rewarding - annual price returns were positive in 47 of 67 calendar years (1946–2012) 70% Return
60 50 40 30 20 10 0 – 10 – 20 – 30 – 40
Return
– 50 ’46
’50
’55
’60
’65
’70
’75
’80
’85
’90
’95
’00
’05
’10 ’12
S&P 500 annual returns are based on the price index only and, therefore, do not include dividends. The index is unmanaged and, therefore, has no expenses. 17
…….and so has short-term volatility Average intra-year price declines were 14.2% over the past 67 years
70% 60
Return
Intra-year gain
Return
Intra-year decline
50 40 30 20 10 0 – 10 – 20 – 30 – 40 – 50 ’46
’50
’55
’60
’65
’70
’75
’80
’85
’90
’95
’00
’05
’10 ’12
Intra-year gain and decline reflect largest price changes within each year. S&P 500 annual returns are based on the price index only and, therefore, do not include dividends. The index is unmanaged and, therefore, has no expenses. 18
5. A look at Life Insurance stocks Strong performers in 2013 but where are they headed?
Picking stocks vs. rating companies – Sell-side analysts try to identify the “best” stocks whereas the goal of credit rating analysts is more to identify quality and claims paying ability. Rating of “A/AA” is excellent whereas an excellent stock pick is one whose: Price rises faster than the market for investors who are long or…. Decreases more steeply than the market for those who are short.
Life stocks have risen an average of 44.8% in 2013 – But they are still on average 6.2% below their YE 2006 level even though the S&P has risen 18.6%. Total industry market capitalization is roughly 2/3 that of Apple’s $440B; clearly we love our Macs, iPhones, iPods and iPads. ROE drives valuation – Average P/B and P/E is currently 1.22x and 10.0x, respectively. Projected industry ROE for 2013 is 11.0%; many may be challenged to get their long-term level back above 13%. 10/21/2013
19
Where Life Insurance Stocks Trade Multiples still below their peak values despite record market levels U.S. Life Insurer Share Valuation Multiples 21.0x
2.5x
19.0x 18.2x 17.0x
2.0x 1.72x
P/B (ex. OCI) Current
13.0x
1.5x 12.0x
12.0x
1.22x
10.7x
10.0x
7.9x
1.0x
0.87x
11.0x
1.01x 0.93x
7.5x 0.83x
0.90x
9.0x
7.9x
7.0x
P/E One Year Forward
15.0x
1.73x
5.0x
0.5x
3.0x
2Q13
2012
2011
2010
2009
2008
2007
1.0x
2006
0.0x
Average P/B (ex. OCI) Current Average P/E one year Forw ard
10/21/2013
Source: Bloomberg
20
9/27/03
10/21/2013 Source: Bloomberg S&P Life SPX TNX
9/27/13
6/27/13
3/27/13
12/27/12
9/27/12
6/27/12
3/27/12
12/27/11
9/27/11
6/27/11
3/27/11
12/27/10
9/27/10
6/27/10
3/27/10
12/27/09
9/27/09
6/27/09
3/27/09
12/27/08
9/27/08
6/27/08
3/27/08
12/27/07
9/27/07
6/27/07
3/27/07
12/27/06
9/27/06
6/27/06
3/27/06
12/27/05
9/27/05
6/27/05
3/27/05
12/27/04
9/27/04
6/27/04
3/27/04
12/27/03
S&P 500 and Life Index
3.00
50
0
TNX
Life Stock Performance
Insurance stocks have closely tracked yields on the 10-year treasury
250
S&P Life Index and S&P 500 vs Ten Year Treasury
5.00
200 4.00
150
100 2.00
1.00
0.00
21
Life Insurer P/B vs. ROE Regression Analysis
10/21/2013
22
6. Wrapping Up Still bullish on life!!!!!
Growth is achievable – Despite positive demographics, the pace of restoring earnings momentum and improving ROE may test the patience of equity markets. Is this an opportunity for new entrants? Diversification, underwriting and investing – Anticipate intensifying focus on building a balanced offering that leverages pricing synergies between lapse and persistency supported products such as LTC combo riders with life insurance and deferred annuities. M&A not a factor – Despite strategic benefits, few deals have resulted in out-performance of the acquirer’s shares. Also, many have enough risk with their own liabilities to want to take on those of others. Private equity more an opportunistic buyer. Life stocks in 2014 – Depends where interest rates are headed 10/21/2013
23
Key Sections 1.
Industry Outlook – Strong potential
2.
Macro Challenges – Low interest rates, equity market volatility, weak economy, Washington unpredictability!
3.
Sources of Risk – Rising capital requirements, long-tail legacy liabilities, regulatory uncertainty
4.
Variable Annuities – Learning from mistakes
5.
Life Insurance Stocks in 2013 – Stellar recovery
6.
Wrapping Up – Steady quality growth is achievable
10/21/2013
2
1. Industry Outlook – Optimistic Are there growth opportunities out there? Post-retirement offers strong potential – Rising longevity, demise of traditional defined benefit pension plans and an aging population are each key demand drivers for retirement income and protection. Only insurers can guarantee lifetime income– Even a 3% inflation rate requires a doubling of income every 23 years; the average length a person can expect to live beyond age 65. No single solution for 75M retiring boomers – Target client is aged 50-70 and possesses both the affluence and urgency to want to solve their retirement financial security needs. 10/21/2013
3
Mortality - good news/bad news Today a $205K life annuity for a 62-year old costs approx. $3.4M; back in 2006 it was $2.2M – an increase of over 50%!!!!!
10/21/2013
Source: MetLIfe
4
The Faces of Retirement
10/21/2013
5
Product design opportunities Can areas of innovation be found in life insurance? Differentiation required in both design and underwriting – Industry needs to move beyond secondary guarantee Universal Life (UL) and overly generous variable annuities (Vas) with living benefits. Indexed UL may be the answer in life insurance – Sales leapt 35% in 2012 to $1.3B or 13% of total industry production. Traditional UL still strong with sales up about 20% to over $3B. Variable annuities can be attractive – Despite the reduction in living benefits they remain a mainstay within IRA rollovers. Managed risk funds have re-energized non-rider sales. Hybrid/combo – Long-term care and Chronic illness riders on life and annuities are generating strong interest. Provides flexibility (no “use it or lose it”) as well as tax advantages and pricing synergies. 10/21/2013
6
2. Headwinds & tailwinds Are life insurers collateral damage from the Fed’s low rate policy?
Industry in reasonable shape – Capital levels are high, liquidity is solid, financial flexibility is good and profitability is improving, albeit slowly with industry long-term ROE’s likely in the 10-13% range. But how fast could this weaken if interest rates don’t begin to rise? Our Achilles heel is long-term interest rates – Between Aug. 2007 Aug. 2012 yield on 10-year U.S. Govt. bonds fell 310 bps to 1.6%. Current level of 2.65% is well below pricing levels and source of rising strain. Federal Reserve has shown little inclination to begin tightening. How quickly should interest rates rise? – Is this the end of a 30-year fixed income bull market? What if it’s not? Low rates putting pressure on long-tailed liabilities; most notably those that relied on aggressive lapse support. But higher rates can bring disintermediation. 10/21/2013
7
Interest rates and credit spreads Federal Reserve’s recent comments suggest no change to current interest rate policy is imminent. 10 Yr. UST
YE 11 YE 12 3Q13 1.89% 1.78% 2.64%
What spread levels are fair value for credit risk on investment grade and high yield debt? What asset classes represent attractive values? Where can you find desirable long duration investments? 8
Investment quality still very solid How much strain are portfolios under from low rates?
General account portfolio growth has been steady – Between 20022012 growth in general account assets rose at a CAGR of 5.5% while policy reserves increased at 5.9%. New investments clearly a challenge with general account yields falling 15-25bps annually. Credit risk has been stable – Since 2002, high yield bonds have held steady at around 5% of total investments and 33% of shareholders equity (ex. OCI). Commercial mortgage arrears have stayed negligible. Have we been taking enough investment risk? Investment losses have been modest – Most portfolios weathered the financial crisis relatively well; particularly vs. banks. Credit losses remain benign in the 20-30 bps range. Tighter spreads and better market liquidity in 2012 gave an opportunity to “cull” weaker credits. 10/21/2013
9
Investment Mix vs. Liabilities
10/21/2013
Source: Company reports
10
Investment quality
10/21/2013
Source: Company Reports
11
3. Key sources of uncertainty What types of risks pose the greatest challenges and what can be done?
Regulatory flux – The role of the Federal Insurance Office is still not clear. PRU and AIG designated as global SIFIs and MET will likely join them. State regulation also undergoing change with principal based reserving, rising capital needs and focus on captive reinsurance. Capital – Risk Based Capital ratios have steadily risen with most insurers above 400% or “AA”. Suggests overcapitalization, but alternative models such as Solvency II in Europe, Treasury stress tests and International Financial Report Standards (IFRS) pose new challenges. Pricing mistakes are immortal – Long-tailed liabilities such as variable annuities (VAs), secondary guarantee universal life (SGUL) and longterm care (LTC) could depress the returns of many insurers for decades to come. Finding investments for this is a challenge. 10/21/2013
12
Risk Based Capital (RBC) ratios Where have Private Equity groups been managing RBC?
10/21/2013
13
Stress test balance sheet leverage Treasury’s assessment of life insurers’ leverage includes general and separate account assets – but not all separate accounts have the same risk Estimated Tier 1 Leverage Ratio of Stock and Mutuals at YE12 Est. Tier 1 Capital to General Account Assets
18.0%
Est. Tier 1 Capital to Total Assets 16.0%
Of Principal’s $119B of separate accounts at 09/30/13, less than $7B were VAs
14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0%
10/21/2013
Na tio nw O hi id o e N at M io n as a sM l ut Pa ual cif Ne ic L if e w Yo No rk Li rt h w fe es te rn Ba nk J.P of A .M m or eric ga a n Ch as W e el ls Fa rg o
To r
AI G ch m ar k Un u St m an co Th r e Ha p rt fo Pr rd in ci pa Af lF la Ge i nw na c n ci Am ort al h Fi er n ip ris anc e Fi ial n Vo an cia ya l -I NG Lin co Me U. S . tL ln if e N a , t Pr I u d io n a n c . en lC t o Pr ial F rp. ot ec inan t iv cia e l Li fe Co rp .
0.0%
Source: Company Reports
14
4. Variable annuities Why are so many insurers pulling back or leaving this business?
What went wrong? – Insurers quick to provide increasingly generous living benefits but slow to recognize they were assuming increased risks as purchaser profile changed. Non-living benefit products are making a resurgence which may suggest appeal of tax deferral. Shift in buyer profile – Increased use of tax-qualified funds, rising age of policyholders and growing use of living benefits confirms trend to use them to provide retirement income. Required minimum distributions (RMDs) from VAs inside RIA’s a growing issue. Product de-risking – Actions taken by insurers include: shift to index funds of existing investments; policy buyouts; higher fees; restrictions on contributions to existing contracts; benefit reductions such as lower withdrawal rates and step-ups; and asset transfer programs. 10/21/2013
15
Managed Volatility Has the financial crisis fundamentally changed investor’s risk tolerance?
An emerging asset class – Can provide a “win-win” for policyholders and insurers as both benefit from a smoother ride. Originally a living benefit de-risking strategy, but it may have broader appeal as an investment option in non-rider VAs, 401(k) plans, and mutual funds. Characteristics – Managed risk funds typically include risk management objectives for volatility, capital protection and fixed income duration. At YE 2012 there were around 118 funds with $87.5B in AUM. Estimate these levels are up over 35% in 2013. Beneficial for policyholders – Produces more stable account values and higher liquidity during periods of equity turmoil. Also reduces "sequence of returns” that those taking systematic withdrawals will exhaust their account balance. 10/21/2013
16
Over time equity markets have risen… In general investing in the equity market has been rewarding - annual price returns were positive in 47 of 67 calendar years (1946–2012) 70% Return
60 50 40 30 20 10 0 – 10 – 20 – 30 – 40
Return
– 50 ’46
’50
’55
’60
’65
’70
’75
’80
’85
’90
’95
’00
’05
’10 ’12
S&P 500 annual returns are based on the price index only and, therefore, do not include dividends. The index is unmanaged and, therefore, has no expenses. 17
…….and so has short-term volatility Average intra-year price declines were 14.2% over the past 67 years
70% 60
Return
Intra-year gain
Return
Intra-year decline
50 40 30 20 10 0 – 10 – 20 – 30 – 40 – 50 ’46
’50
’55
’60
’65
’70
’75
’80
’85
’90
’95
’00
’05
’10 ’12
Intra-year gain and decline reflect largest price changes within each year. S&P 500 annual returns are based on the price index only and, therefore, do not include dividends. The index is unmanaged and, therefore, has no expenses. 18
5. A look at Life Insurance stocks Strong performers in 2013 but where are they headed?
Picking stocks vs. rating companies – Sell-side analysts try to identify the “best” stocks whereas the goal of credit rating analysts is more to identify quality and claims paying ability. Rating of “A/AA” is excellent whereas an excellent stock pick is one whose: Price rises faster than the market for investors who are long or…. Decreases more steeply than the market for those who are short.
Life stocks have risen an average of 44.8% in 2013 – But they are still on average 6.2% below their YE 2006 level even though the S&P has risen 18.6%. Total industry market capitalization is roughly 2/3 that of Apple’s $440B; clearly we love our Macs, iPhones, iPods and iPads. ROE drives valuation – Average P/B and P/E is currently 1.22x and 10.0x, respectively. Projected industry ROE for 2013 is 11.0%; many may be challenged to get their long-term level back above 13%. 10/21/2013
19
Where Life Insurance Stocks Trade Multiples still below their peak values despite record market levels U.S. Life Insurer Share Valuation Multiples 21.0x
2.5x
19.0x 18.2x 17.0x
2.0x 1.72x
P/B (ex. OCI) Current
13.0x
1.5x 12.0x
12.0x
1.22x
10.7x
10.0x
7.9x
1.0x
0.87x
11.0x
1.01x 0.93x
7.5x 0.83x
0.90x
9.0x
7.9x
7.0x
P/E One Year Forward
15.0x
1.73x
5.0x
0.5x
3.0x
2Q13
2012
2011
2010
2009
2008
2007
1.0x
2006
0.0x
Average P/B (ex. OCI) Current Average P/E one year Forw ard
10/21/2013
Source: Bloomberg
20
9/27/03
10/21/2013 Source: Bloomberg S&P Life SPX TNX
9/27/13
6/27/13
3/27/13
12/27/12
9/27/12
6/27/12
3/27/12
12/27/11
9/27/11
6/27/11
3/27/11
12/27/10
9/27/10
6/27/10
3/27/10
12/27/09
9/27/09
6/27/09
3/27/09
12/27/08
9/27/08
6/27/08
3/27/08
12/27/07
9/27/07
6/27/07
3/27/07
12/27/06
9/27/06
6/27/06
3/27/06
12/27/05
9/27/05
6/27/05
3/27/05
12/27/04
9/27/04
6/27/04
3/27/04
12/27/03
S&P 500 and Life Index
3.00
50
0
TNX
Life Stock Performance
Insurance stocks have closely tracked yields on the 10-year treasury
250
S&P Life Index and S&P 500 vs Ten Year Treasury
5.00
200 4.00
150
100 2.00
1.00
0.00
21
Life Insurer P/B vs. ROE Regression Analysis
10/21/2013
22
6. Wrapping Up Still bullish on life!!!!!
Growth is achievable – Despite positive demographics, the pace of restoring earnings momentum and improving ROE may test the patience of equity markets. Is this an opportunity for new entrants? Diversification, underwriting and investing – Anticipate intensifying focus on building a balanced offering that leverages pricing synergies between lapse and persistency supported products such as LTC combo riders with life insurance and deferred annuities. M&A not a factor – Despite strategic benefits, few deals have resulted in out-performance of the acquirer’s shares. Also, many have enough risk with their own liabilities to want to take on those of others. Private equity more an opportunistic buyer. Life stocks in 2014 – Depends where interest rates are headed 10/21/2013
23
