Fair Value Accounting for GMxB Riders Shaio-Tien Pan SOA Antitrust - PDF document

Equity-Based Insurance Guarantees Conference Nov. 5-6, 2018 Chicago, IL Fair Value Accounting for GMxB Riders Shaio-Tien Pan SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer Sponsored by

Fair Value Accounting for GMxB Riders SHAIO-TIEN PAN Actuarial Director, PwC 2018 EBIG Conference (Session 3B) 5 November 2018 (1530 – 1700 hours)

GAAP LTDI – History & background • The existing U.S. GAAP multi-model accounting approach for insurance contracts evolved over the GAAP LTDI objectives decades, often in response to new product features. 1. Improve the timeliness of the • FASB began proactively working with the IASB in 2008 liability for future policy benefits on an exposure draft of fundamental changes to the with assumptions updates accounting for insurance contracts. 2. Simplify and improve the • In the summer of 2013, FASB released its proposed accounting for GMxB in comprehensive new standards for insurance. variable contracts 3. Simplify DAC amortization • In February of 2014, the FASB voted to change its course toward making ‘targeted improvements’ for long-duration 4. Improve the effectiveness contracts. GAAP LDTI begins. of the required disclosures • In April of 2014, the target areas are chosen: unit of account, liability calculations, DAC amortization, loss recognition, and revenue recognition. • The LDTI exposure draft was issued in 2016. It was redeliberated in 2017-18, with significant changes made; the effective date has been announced to be 2021 for public companies. The final version was released August 15, 2018 2

FASB Long-Duration Targeted Improvements (LDTI) – History and adoption timeline Who does it affect? All public and private companies that report on a US GAAP basis. August 2018 Further secondary impacts to any Issuance of 1 st half 2016 February final standard firms that have adopted a modified 2014 Re-deliberations June 2018 US GAAP basis. FASB decided to completed in March Final drop its comprehensive 2016; FASB votes to deliberations insurance project and draft a revised focus on targeted March 2017 document When does it take effect? improvements Public roundtable for exposure Adoption dates are the following for calendar year-end companies: • Public companies – 2014 2015 2016 2016 2017 2018 2019 2020 2021 2022 Beyond Jan 1, 2021 • Private companies - Jan 1, 2022 Early adoption is acceptable August, October, August 2014 September 2016 2021 2022 and November 2017 FASB begins FASB exposure Public companies Private companies re-deliberations draft issued with Board Meetings to Effective Effective January 1, 2022 on long duration comment period discuss tentative January 1, 2021 What will be required? decisions targeted improvements ending 12/15/16 Three years comparative income based on scope agreed upon in statements at date of first reporting April 2014 after adoption (e.g. for public companies comparative will be required from 2019). 3

FASB Long-Duration Targeted Improvements (LDTI) – overview of changes What is changing? 01 02 • Assumptions updates for • For contract features that have other- for non-participating than-nominal capital market risks traditional and limited- • Fair value measurement through payment insurance contracts. income • Discount rate will be based • Change in instrument-specific credit on upper medium grade (low risk recognized in OCI Targeted credit risk) fixed-income Improvements for instruments. • Eliminate PAD and loss Long-Duration recognition testing. Contracts 04 03 • New disclosure requirements including • DAC will be amortized on a liability roll forwards and information constant basis over the life of about significant inputs, judgements the contract, independent of and assumptions. profitability • No interest accretion • No impairment test. 4

GAAP LTDI - Impact on Annuity GMxB’s GMx MxB Current G GAA AAP New G GAAP VA GMDB SOP03-1 Ma Market R Risk Be Benefit ( (MR MRB) • Payment is a result of an identifiable insurable  To be measured at Fai air V Val alue event  Changes in fair value flow through VA GMAB FAS 157 P/L, except changes in instrument- specific credit risk recognized in • VA GMIB Typically SOP 03-1 Other Comprehensive Income • FAS 157 if benefit is net settled  If a contract contains multiple MRB, • Typical for reinsurance those MRBs shall be bundled • Some consider automatic annuitization together as a single compound feature net settlement market risk benefit • VA GMWB/GLWB Typically FAS 157 for non-lifetime GMWBs • Diversity in practice exists for lifetime GMWBs • Full-FAS 157 • Hybrid FAS 157/SOP03-1 Note: FIA’s index crediting feature is not considered FIA GMxB Typically SOP 03-1 MRB, and will continue to be accounted for as embedded derivatives under ASC 815 5

Transition Transition Date: 1/1/2019 2019 ○ Adoption in 2021 would require adjustment to the 2020 and 2019 ○ comparative periods Ful ull r ret etrosp spec ective e method must be used for MRB ○ Benefit of hindsight may be used for the full retrospective method to the extent ○ that assumptions in prior periods are unobservable or otherwise unavailable and cannot be independently substantiated. 6

GMxB Financial Impact Assessment Opening Eq g Equity ty a at Profi fit Em t Emergence Ear arnin ings V Vola olatilit lity Tota tal Eq Equity ty Vola olatilit ility Tran ansit itio ion (New b w business) Variable Annuity Adverse Adverse Adverse Adverse FIA with GMxB Adverse Adverse Adverse Adverse • The expected adverse impact primarily due to Guarantees currently accounted for under SOP 03-1 (GMDBs, GMIBs, etc) will now be measured at fair value under the new definition of Market Risk Benefits (MRBs) • Further analysis based on company specific circumstances is recommended to assess the potential financial impacts of the new guidance • Potential levers to manage these metrics: Hedging strategy 7

FASB LDTI – Implications for insurers LDTI will impact all aspects of an insurer’s operations - going beyond just the finance and actuarial functions including product design and distribution, capital management and hedging, strategic planning, commercial decisions and market communications Strategic Implications Technical Challenges • Earnings volatility and risk • DAC calculation sensitivity • Transition • Increased disclosures • Fair value market • Budgeting and strategic planning risk benefits • Product decisions • Disclosure • Hedging • Annual incentive plans Top LDTI i tems Business Operation Challenges • Capturing new and additional data Implementation & points; historical data points Transition Challenges • Finance, actuarial and IT resources needed for transition • PMO and interactions to inflight projects • Actuarial valuation & reporting • Parallel reporting during 2020 infrastructure • Board and Executive Team training • New financial reporting controls • Management of external communications 8

Implications on GMxB Hedging  Hedge Objective  Pre-2021: What to hedge toward between the Transition Date (2019) and the Effective Date (2021)?  Post-2021: Economics vs New GAAP vs Stat(also new)  Cost of Hedging  Higher notional required  Potential rise in implied volatility due to increased demand for option hedges  Hedge Strategy  Rho & Vega coverage  Gamma coverage  Dynamic vs Static  Rebalance threshold  Other factors  Wall Street analysts & investors expectations  Rating Agencies’ viewpoints  Company’s risk appetite 9