1 Indexing Options and More June 20, 2012 Tim Hill, FSA, MAAA Milliman, Inc.

2 A Historical Look at US FIA Annual Sales Source: AnnuitySpecs

3 Full year 2011 FIA Sales Results Full year 2011 VA Sales – Top Ten Companies ($ in millions) 12/31/ 11 Rank Company2011 Sales % Chg. vs Q4 11Mkt Share 1Allianz Life$6, %19.5% 2Aviva4, %13.9% 3American Equity4,3716.4%13.5% 4GAFRI1, %5.7% 5North American1,6738.4%5.2% 6Lincoln National1, %5.0% 7Midland National1, %4.8% 8Jackson National1, %4.6% 9ING1, %4.2% 10Security Benefit941New2.9% Source: AnnuitySpecs

4 Rate Environment – June 16, 2012

5 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

6 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

7 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

8 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

9 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%

10 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%

11 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%

12 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

13 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.

14 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

15 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