Thinking Beyond The Traditional Risk Management Programs Sheldon - PDF document

Equity-Based Insurance Guarantees Conference Nov. 5-6, 2018 Chicago, IL Thinking Beyond The Traditional Risk Management Programs Sheldon Epstein SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer Sponsored by

Thinking Beyond The Thinking Beyond The Traditional Risk Traditional Risk Management Management Programs Programs Sheldon Epstein Sheldon Epstein A CONFIDENTIAL PRESENTATION EBIG 2018 - 5 November 2018 Session 1A (1045 – 1215 hours) Proprietary Reinsurance Solutions

Aga m Ca pita l Ma na gement Importa nt Disclosures This confidential preliminary information has been prepared by Agam Capital Management (“Agam”) solely for information purposes and is being furnished solely to assist the recipient in deciding whether to proceed with further analysis of the transaction contemplated herein. This document does not constitute an offer or invitation for the sale or purchase of securities. The information set out herein is preliminary and should not be relied upon for any purpose. does not make any representation or warranty, express or implied, as to the accuracy or completeness of the information contained herein and shall not have any liability for such information. Interested parties should conduct their own investigation and analysis of Agam, its business, prospects and prospective results of operations and financial condition. Except for internal use, this information may not be excerpted from, summarized, distributed, reproduced or used without the prior written consent of Agam. The investment opportunity described herein is speculative and entails a high degree of risk. Due to the illiquidity of this investment, if you invest, you must expect to bear the economic risk of the investment for an indefinite period. Agam expects that no market will develop for the potential investment opportunity described herein. Certain statements in this document that are not historical fact constitute "forward-looking statements." You are cautioned not to place undue reliance on these forward-looking statements. Agam generally identifies forward-looking statements by using words like "believe," "intend," "target," "expect," "estimate," "may," "should," "plan," "project," "contemplate," "anticipate," "predict" or similar expressions. You can also identify forward-looking statements by discussions of strategies, plans or intentions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results of Agam to be materially different from historical results or from any results expressed or implied by such forward-looking statements. All forward- looking statements herein are qualified in their entirety by this cautionary statement. Agam made the statements in these materials as of the date hereof unless it is stated otherwise. Neither the delivery of these materials, nor any sale of securities by Agam after the date of these materials, shall create any implication that the information contained herein or the affairs of Agam have not changed since the date hereof or that such information is correct as of any time subsequent to its date. Agam management based all estimates and projections as to events that may occur in the future upon their best judgment as of the date of these materials and upon assumptions and circumstances and events that have not yet taken place, may not have an empirical basis, are subject to variation and are inherently unpredictable. Whether or not such estimates or projections may be achieved will depend upon Agam achieving its overall business objectives and the availability of funds, including funds from the sale of securities. There can be no assurance that any estimates or assumptions will prove accurate or that any of the projections will be realized. Agam does not guarantee that any of these projections will be attained. Actual results will vary from the projections, and such variations may be material. You should not construe the contents of these materials as legal, tax or investment advice. You should consult your own counsel, accountant or business advisor as to legal and other matters concerning any investment decisions. These materials are not all-inclusive. Nor do they contain all the information which you may require. Consult your own legal, tax or investment counsel regarding the legality or suitability of your investment under applicable legal, investment or similar laws, regulations or fiduciary standards. Agam does not make any representation regarding your investment herein under any legal, investment or similar law, regulations or fiduciary standards. The information in this document is not targeted at the residents of any particular country and is not intended for distribution to, or use by, any person in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Furthermore, no investment opportunity will be extended to persons resident in any jurisdiction or country where such distribution would be contrary to local law or regulation. 2

Introduction • Overview of risk-management strategies deployed by Variable Annuity (VA) companies to hedge their riders • Current alternatives to the predominant strategies • Innovative and practical ways of managing VA contract risks more effectively in a cost- efficient manner. 3

Overview of risk- ma na gement stra tegies deployed by VA hedgers Dyna mic Replica tion • Overview • In Dec. 2016, Milliman published “How effective is variable annuity guarantee hedging?” • They defined “Hedge Effectiveness” • Effectiveness of loss recovery can be measured by the ratio of the change in hedge asset value to change in liability increase during a market downturn. • Definition is focused on GAAP P&L volatility rather than targeting other metrics such as statutory solvency • In particular the general observation is that most companies target hedging VA guarantees that fall under FAS 133/157 since they respond to capital market inputs, • The most common approach is to employ a “2-Greek” strategy (Delta and Rho) • When listed equity options are utilized, companies tend to position shorter-dated options than would be derived from liability sensitivities • FASB long-dated contract improvements would move all of the VA guarantees to FAS 133/157 4

Overview of risk- ma na gement stra tegies deployed by VA hedgers Dyna mic Replica tion • Risks • Basis Risk • Gap Risk • Vega Risk • Estimation of higher order Greeks • Cross-Market Correlation • Statutory vs GAAP vs “Economic” mismatches 5

Overview of risk- ma na gement stra tegies deployed by VA hedgers Investment Constra ints a nd Ma na ged Vola tility Funds • Objective: Minimize the volatility of the underlying separate account values by enforcing stylistic or algorithmic allocations • CPPI • Investment allocation constraints • Managed Volatility Funds • These approaches rely to some extent on • positive correlation of rates and equity price movements; • algorithmic approaches also rely on the observation that implied/realized volatility increases with a large directional move • Two observations • Volatility Managed Funds do achieve underlying target volatility • Algorithmic approaches tend to ignore observed mean reversion in price movements serially over time leads to a whipsaw effect potentially reducing future fund growth 6

Overview of risk- ma na gement stra tegies deployed by VA hedgers Ta rgeting non- GAAP metrics • A number of public VA writers have disclosed in their earnings disclosures and SEC filings that they are targeting statutory capital either primarily or secondarily 1. “In addition to our dynamic hedging strategy, we have recently implemented static hedge positions designed to mitigate the adverse impact of changing market conditions on our statutory capital. ” • Dynamic Replication with Statutory Overlay 2. “We focus our hedging activities primarily on mitigating the risk from larger movements in capital markets, which may deplete variable annuity contract holder account values, and may increase long- term variable annuity guarantee claims. “ • Targeting Long Term Solvency and not short term volatility 3. “Certain of our products, particularly our variable annuity products,…,we may choose to hedge these risks on a basis that does not correspond to their anticipated or actual impact upon our results of operations or financial position under U.S. GAAP” • Keep an eye on GAAP but target enterprise risk 4. AGAM: Target statutory solvency within variable annuities and economic value as an overlay across all products 7