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Life Insurance Industry in the United States

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Title: Life Insurance Industry in the United States


1
Life Insurance Industry in the United States
  • Presented by
  • William Leung
  • Annie Lau
  • Aaron Cawker
  • Jeffery Pat
  • Alex Kwan

2
Agenda
  • Introduction of Life Insurance Industry
  • Sun Life Canada Group
  • Prudential Insurance
  • Manulife Financial
  • Recommendation

3
Structure of the Industry

4
Background
  • Over 2000 life insurance companies in the US
  • Admitted Assets totaled 3.26trillion at the end
    of 2001
  • Top 10 insurers accounted for 45 of the assets
  • Top 3 accounted for 20

5
Change in the industry
  • A business of shared risk
  • Historically only provide one service financial
    remuneration when the policyholder dies
  • Today an array of financial services
  • Face direct competition from banks and other
    financial intermediates (Substitutes)

6
Ownership Structures
  • Stock insurance companies
  • Publicly traded
  • Mutual insurance companies
  • Owned by policyholders
  • Mutual holding companies
  • Combination of the two structures
  • Trend toward demutualization

7
Revenue and Cost Structure

8
Companies Revenue
  • Declined by 15 in 2001
  • Two sources
  • Premiums
  • Investment Income

9
Income in 2001
10
Companies expenses
  • Declined by 14.7 in 2001
  • Three sources
  • Benefits paid out (Declined by 18.9)
  • Death benefits
  • Annuity benefits
  • Disability benefits
  • Accident and heath benefits
  • Surrender benefits
  • Reserve additions
  • Operating expenses (Declined by 18.1)

11
Expense in 2001
12
Types of Products
13
Types of Products
14
Types of Products
  • Term Insurance
  • Life insurance that remains in effect for a set
    period or a set term
  • No build-up cash value or forfeiture value

15
Types of Products
  • Whole Life
  • Combines a death benefit with a forced savings
    plan
  • Premium levels remain constant
  • Carries a surrender value
  • Death benefit is exempt from income taxes

16
Types of Products
  • Group Life
  • Life insurance coverage provided under a group or
    association program

17
Types of Products
  • Other policies
  • Credit Life Insurance
  • Term life insurance designed to cover the
    repayment of a loan, installment purchase, or
    other financial obligation
  • Industrial Life Insurance
  • A relatively low-value form of life insurance
    whereby the premium is collected by the
    salesperson at the home of the insured on a
    weekly or monthly basis

18
Types of Products
  • Annuities
  • Provides a series of payments to the annuity
    holder
  • Immediate annuity or deferred annuity
  • Money deposited before the commencement of
    payments earns income on a tax-deferred basis
  • In 2001, individual group annuities accounted
    for 53 of insurers total premiums

19
Technology
20
Technology
  • Local Area Computer Networks
  • Faster processing of applications and claims
  • More rapid matching of policies and premiums
  • Instant Actuarial Analysis
  • More rapid accurate pricing of customized
    products
  • Internet Sales
  • Customers may access product information, or file
    a claim on the Internet

21
Regulatory Environment
22
Regulatory Environment
  • Each state grants operating licenses to insurers
  • State Regulators
  • Approval of products agents
  • National Association of Insurance Commissioners
    (NAIC)

23
Regulatory Environment
  • Each year, insurance companies are required to
    file a set of financial statements with the
    regulators
  • Financial Services Modernization Act (1999)
  • Uniform product filing form
  • National agent licensing plan

24
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25
Company Background
  • Leading financial services organization
    headquartered in Toronto, with operations in key
    markets around the world

26
International Operations
27
Stock Chart
  • Current stock price 31.89

28
Products and Services
  • Offers financial products and services that fall
    into two main business areas
  • Wealth Management
  • Asset management, mutual funds, pension plans,
    and annuities operations
  • Protection
  • Life and health insurance, reinsurance operations

29
Revenue by Industry
30
Total Revenue
31
Expenses and Other
32
Operating Expenses
33
Investments
34
Bonds by Investment Grade
35
Risk Management Team
  • Board of Directors appoint the Risk Review
    Committee
  • Dedicated to oversight the risk management within
    the company
  • No member of this committee is an employee of the
    company

36
Claims Risk
  • Risk of incurring higher than anticipated claim
    losses on any one policy
  • Underwriting procedures to determine insurability
    of applicants
  • Manage exposure to large claims

37
Concentration Risk
  • Risk of major losses resulting from an
    overexposure to an industry segment
  • Buys reinsurance from reliable 3rd parties
  • Regularly evaluates the financial condition of
    the reinsurers

38
Operation Risk
  • Worldwide and specific policies for each market
    in which it operates
  • Ongoing training through internal and external
    program to reduce number of errors
  • Review and upgrade information systems and
    technology where necessary

39
Liquidity Risk
  • Liquefiable assets equal to at least 100 of all
    liabilities payable on demand
  • Maintain minimum levels of cash and money market
    investment as a of total investment assets

40
Credit Risk
  • Credit and underwriting policies
  • Company policy limits credit exposure to 4 of
    consolidated equity invested in any single issuer
    and to 8 of consolidated equity invested in any
    associated group of issuers
  • Transacts derivatives contracts with
    counterparties rated AA or better

41
Market Risk
  • Diversify stock holdings by industry type and
    corporate entity
  • Diversify real estate holdings by location and
    property type
  • Earning-at-Risk measurement model
  • Equity index futures, swaps and other options

42
Sensitivities of Earnings
43
Interest Rate Risk
  • Matching policy for each portfolio of assets and
    liabilities
  • Management of the duration gap of assets and
    liabilities
  • Duration gap analysis measures sensitivity of
    assets, liabilities and off-balance sheet
    instruments in interest rate changes
  • Interest rate swaps and options

44
Foreign Currency Risk
  • Assets and liabilities that held in each
    jurisdiction are denominated in local currencies
  • Provide effective operational hedge against
    currency fluctuations
  • Currency swaps and forward contracts
  • 2002 Annual Report

45
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46
Prudential Financial
  • On December 18, 2001, Prudential Insurance
    converted from a mutual life insurance company
    owned by its policyholders to a stock life
    insurance company and became an indirect, wholly
    owned subsidiary of Prudential Financial.

47
Prudential Financial
48
Products
  • Life insurance
  • Property and casualty insurance
  • Mutual funds, annuities, and pension
  • Asset management, securities brokerage, banking
    and trust services
  • Real estate brokerage franchises, and relocation
    services.

49
Revenues and Expenses
  • Revenues
  • insurance premiums mortality, expense, and asset
    management fees commissions
  • Expenses
  • insurance benefits provided, general business
    expenses, dividends to policyholders, commissions
    and interest credited on general account
    liabilities.

50
Profitability
  • Ability to price and manage risk on insurance
    products
  • Ability to attract and retain customer assets
  • Ability to manage expenses.

51
Other Factors
  • Regulation
  • Competition
  • Interest rates, taxes, foreign exchange rates
  • Securities market and general economic conditions

52
Market risk
  • Risk of change in value of financial instruments
    as a result of absolute or relative changes in
  • interest rates
  • foreign currency exchange rates
  • equity or commodity prices.

53
Risk Management
  • Risk managers establish investment risk limits
    for exposures to any issuer, geographic region,
    type of security or industry sector
  • Tools and techniques
  • Sensitivity and Value-at-Risk (VaR) measures
  • Hedging methods
  • Position and other limits based on type of risk
  • Set by management and approved by Board of
    Directors

54
Interest Rate Risk
  • Asset/liability management
  • Match interest rate sensitivity of the assets to
    the underlying liabilities
  • Limit net change in value of assets and
    liabilities arising from interest rate movement
  • Set target duration mismatch constraints
  • Portfolio stress testing
  • Impact of altering interest-sensitivity
    assumptions under various moderately adverse
    interest rate environment

55
Interest Rate Risk
  • Measure price sensitivity to interest rate change
  • Duration measures relative sensitivity of fair
    value of a financial instrument to changes in
    interest rates
  • Convexity measures rate of change of duration
    with respect to changes in interest rates

56
Equity Price Risk
  • Match risk profile of equity investments against
    risk-adjusted equity market benchmarks (SP 500
    and Russell 2000)
  • Target price sensitivities approximate benchmark
    indices
  • Hypothetical 10 decline in equity benchmark
    market levels
  • measure risk in terms of decline in fair market
    value of equity securities hold
  • 281M (Dec,2002) ? Fair market value of equity
    securities decline from 2.807B to 2.526B

57
Foreign Currency Exchange Rates Risk
  • Invest in assets denominated in same currencies
    as liabilities
  • Foreign exchange forward contracts and currency
    swaps
  • VaR analysis (95CI, 1mo time horizon)
  • Estimated VaR 9M (Dec,2002)
  • Hypothetical decline of foreign currency asset
    not hedged from 494M to 485M

58
Types of Derivative Instruments
  • Interest rate swaps
  • Int. rate risk associated with value of mortgage
    loans Co. has originated and plans to securitize
  • Treasury futures
  • Hedge duration mismatch btw asset/liab by
    replicating Treasury performance
  • Index options
  • Hedge against decrease in value of Co. equity
    portfolio

59
Types of Derivative Instruments
  • Currency futures, options and swaps
  • Currency exchange rates risk for investments
    denominated in foreign currencies Co. holds
  • Credit derivatives
  • Enhance return on Co.s investment portfolio
    providing comparable exposure to fixed income
    securities that might not be available in primary
    market

60
Financial Data
  • Balance Sheet
  • Income Statement
  • Cash Flow Statement

61
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62
Manulife Financial
  • Manulife Financial has established an integrated,
    enterprise-wide framework for managing all risks
    across the organization.
  • The framework guides all risk-taking activities
    and ensures that they are aligned with the
    Companys overall risk-taking philosophy as well
    as shareholder and customer expectations.

63
Major Risk Categories
Manulifes risk framework sets out about 40 risks
covering five broad categories
  • Strategic
  • Product
  • Asset, Liability and Market
  • Interest rate risk
  • Equity and real estate market risk
  • Foreign currency risk
  • Liquidity risk
  • Credit
  • Operational

64
The enterprise risk management framework is built
around four key elements
  • Comprehensive Risk Governance
  • Effective Risk Management Policies and Processes
  • Rigorous Risk Exposure Measurement
  • Risk Limit Management

65
Risk Governance
  • The Board of Directors, through its Audit and
    Risk Management Committee and Conduct Review and
    Ethics Committee, has overall responsibility for
    overseeing the Companys risk-taking activities
    and risk management programs.

66
  • The Chief Executive Officer (CEO) is directly
    accountable to the Board of Directors for all of
    Manulife Financials risk-taking activities and
    risk management programs. The executive
    management structures that support the CEO
    include the Chief Financial Officer, the
    Corporate Risk Management Committee and
    subcommittees, and the Chief Risk Officer, who is
    responsible for administering the Companys
    enterprise risk management program.

67
Risk Management Polices and Processes
  • The Companys enterprise risk management
    framework provides the overall infrastructure
    designed to ensure all risks to which the Company
    is exposed are managed using a common set of
    standards and guidelines.
  • The framework integrates a series of specific
    risk management programs administered through the
    Companys risk committees and risk managers.
  • These comprehensive programs incorporate the
    following key components
  • policies and limits
  • processes for risk identification, assessment,
    measurement, monitoring and reporting
  • risk management accountabilities
  • delegated authorities
  • control and mitigation strategies

68
Risk Measurement
  • Individual measures are used to assess risk
    exposures from various risks.
  • In aggregate, the Company uses the risk-based
    capital required by its regulator, or Minimum
    Continuing Capital and Surplus Requirements
    (MCCSR), as a measure of overall capital at
    risk.
  • The Company allocates capital on this basis and
    evaluates returns on this risk-based capital.
    This is supplemented in some situations by an
    economic-based capital at risk measure that
    reflects the probable maximum loss of capital
    that could occur over a specific time horizon
    with a certain degree of confidence.
  • Enterprise-wide, integrated stochastic
    scenario-based projection models are being
    developed to implement the integrated risk
    measurement framework.

69
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70
Risk Limit Management
  • The Company has established a defined capacity
    for assuming risk, considering the risk
    tolerances of the Board of Directors and
    management and the Companys financial condition.
  • The overall capacity is defined in terms of the
    Companys MCCSR ratio. This is the ratio of the
    Companys available capital to its risk-based
    capital requirements, as defined by its
    regulator.
  • Manulife Financial targets an MCCSR ratio of at
    least 180 per cent.
  • To limit exposure to specific risks, the Company
    has established enterprise-wide limits for
    various asset liability and market risks, and
    credit risks, based on the individual risk
    exposure measures used to assess these risks.

71
The risk of loss resulting from the inability to
adequately plan or implement an appropriate
business strategy, or to adapt to change in the
external business, political or regulatory
environment.
STRATEGIC RISK
  • Manulife Financial faces many strategic and
    environmental challenges, including product,
    service and distribution competition, changing
    political and regulatory environments, and
    potential loss of reputation.

72
PRODUCT RISK
Product risk is the risk of loss due to actual
experience emerging differently than assumed when
the product was designed and priced, as a result
of investment returns, expenses, taxes, mortality
and morbidity claims, and policyholder behaviour.
  • The Companys product design and pricing risk is
    managed through a program, overseen jointly by
    the Chief Actuary and Chief Risk Officer,
    incorporating standards and guidelines designed
    to ensure the level of risk borne by the Company
    is within acceptable levels and is consistent
    with its targeted profile.
  • The standards and guidelines cover
  • product design
  • pricing models and software
  • pricing methods and assumption setting
  • Documentation
  • stochastic and stress scenario analysis
  • approval processes
  • risk-based capital allocations
  • experience monitoring programs
  • profit margin objectives

73
PRODUCT RISK
  • Claims risk is diversified as a result of the
    Companys international operations with a wide
    range of insured individuals and products
    covering varied risk events.
  • Exposure to individual large claims is mitigated
    through established retention limits per insured
    life varying by market and jurisdiction, reviewed
    periodically and approved by the CEO. Coverage in
    excess of these limits is reinsured with other
    companies.
  • The current retention limits in Canada and the
    U.S. are 10 million in local currency (15
    million for joint life policies).
  • For direct written business, current retention
    limits are Yen 500 million in Japan and U.S.
    100,000 in Hong Kong and, for assumed
    reinsurance, are U.S. 10 million in both Japan
    and Hong Kong.
  • Local concentration risk is mitigated through the
    use of aggregate retention limits for certain
    covers and through catastrophe reinsurance for
    life and disability insurance worldwide.
  • The Companys catastrophe reinsurance covers
    losses in excess of U.S. 50 million, up to U.S.
    150 million (U.S. 100 million for Japan) and
    covers losses due to certain terrorist activities
    in Canada, where the bulk of this concentration
    risk is located.

74
ASSET, LIABILITY AND MARKET RISK
  • The risk of loss resulting from market price
    volatility, interest
  • rate changes, adverse movements in foreign
    currency rates, and
  • from not having access to sufficient funds to
    meet both expected
  • liabilities and unexpected cash demands.
  • The Companys asset liability and market risk
    management program is carried out through a
    network of asset liability committees.
  • Global investment policies, approved by the Audit
    and Risk Management Committee, establish
    enterprise-wide and portfolio level targets and
    limits and establish delegated approval
    authorities.
  • The targets and limits are designed to ensure
    investment portfolios are widely diversified
    across asset classes and individual investment
    risks.
  • Actual investment positions are monitored
    regularly. They are reported to the asset
    liability committees monthly and to the Corporate
    Risk management Committee and Audit and Risk
    Management Committee quarterly.

75
ASSET, LIABILITY AND MARKET RISK
76
Segmentation and Asset Mix
ASSET, LIABILITY AND MARKET RISK
  • The foundation of the asset liability and market
    risk management program is the segmentation of
    product liabilities with similar characteristics
    and the establishment of investment policies and
    goals for each segment.
  • The Company invests in assets with
    characteristics that closely match the
    characteristics of the liabilities they support.
  • The Company uses derivatives, including foreign
    exchange contracts, interest rate and cross
    currency swaps, forward rate agreements and
    equity options, to manage interest rate, foreign
    currency and equity risk.

77
ASSET, LIABILITY AND MARKET RISK
Interest Rate Risk
  • Interest rate changes may result in losses if
    asset and liability cash flows are not closely
    matched with respect to timing and amount.
  • The Company measures and manages interest rate
    risk exposure using a variety of sophisticated
    measures, including cash flow gaps, durations,
    key rate durations, convexity, and economic value
    at risk based on both stochastic scenarios and
    predetermined scenarios.
  • The exposure related to insurance segments arises
    primarily in Japan segments in which the duration
    of assets held is shorter than that of
    liabilities to allow the Company to take
    advantage of potential interest rate increases.

78
ASSET, LIABILITY AND MARKET RISK
Equity and Real Estate Market Risk
  • Fluctuations in equity market prices, and to a
    lesser extent real estate prices, may impact
    returns on assets held in the general fund, fee
    income earned on market-based funds, and
    liabilities associated with investment-related
    guarantees, primarily on variable annuities and
    segregated funds.
  • The Company projects future guaranteed benefit
    payments under a variety of stochastic market
    return scenarios, also considering future
    mortality and policy termination rates. The
    Company is required to hold actuarial liabilities
    for these contingent benefit payments sufficient
    to cover the average of the worst 40 per cent
    market return scenarios.

79
ASSET, LIABILITY AND MARKET RISK
Equity and Real Estate Market Risk
  • Equity holdings are diversified and managed
    against established targets and limits by
    industry type and corporate connection.

80
ASSET, LIABILITY AND MARKET RISK
Foreign Currency Risk
  • The Company may be exposed to losses resulting
    from adverse movements in foreign exchange rates
    due to the fact that it manages operations in
    many currencies and reports financial results in
    Canadian dollars.

81
ASSET, LIABILITY AND MARKET RISK
Liquidity Risk
  • The Companys global liquidity risk management
    program incorporates policies and procedures
    designed to ensure that adequate liquidity is
    available.
  • These policies and procedures include
  • designing products to reduce the possibility of
    unexpected liquidity demands
  • centrally forecasting and monitoring actual cash
    movements on a daily basis
  • maintaining investment portfolios with adequate
    levels of marketable investments and
  • maintaining access to other sources of liquidity
    such as commercial paper funding and committed
    standby bank credit facilities.

82
CREDIT RISK
  • Credit risk is the risk of loss due to the
    inability or unwillingness
  • of a borrower or counterparty to fulfill its
    payment obligations.
  • The Companys credit risk management program,
    overseen by the Credit Committee, incorporates
    policies and procedures that emphasize the
    quality and diversification of the Companys
    investment portfolio and establishes criteria for
    the selection of counterparties and
    intermediaries.
  • An allowance for losses on invested assets is
    established when an asset or portfolio of assets
    becomes impaired as a result of deterioration in
    credit quality, to the extent there is no longer
    assurance of timely realization of the carrying
    value of assets and related investment income.

83
CREDIT RISK
  • The carrying value of an impaired asset is
    reduced to net realizable value at the time of
    recognition of impairment.

84
CREDIT RISK
85
OPERATIONAL RISK
  • Operational risk is the risk of loss resulting
    from inadequate or
  • failed internal processes, systems failures,
    human performance
  • failures or from external events.
  • The Companys operational risk management
    programs seek to minimize exposure by ensuring
    appropriate internal controls and systems,
    together with trained and competent people, are
    in place throughout the Company.
  • A global business continuity program is in place
    to ensure key business functions can continue and
    normal operations can resume effectively and
    efficiently in the event of a major disruption.

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