Life Insurance Industry in the United States

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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

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Companies Revenue

• Declined by 15 in 2001
• Two sources
• Premiums
• Investment Income

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Income in 2001
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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)

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Expense in 2001
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Types of Products
13
Types of Products
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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

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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

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Types of Products

• Group Life
• Life insurance coverage provided under a group or
  association program

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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

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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

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Technology
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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

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Regulatory Environment
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Regulatory Environment

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

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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

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Company Background

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

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International Operations
27
Stock Chart

• Current stock price 31.89

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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

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Revenue by Industry
30
Total Revenue
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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

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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

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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

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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

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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

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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

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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

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Sensitivities of Earnings
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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

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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

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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.

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Prudential Financial
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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.

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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.

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Profitability

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

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Other Factors

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

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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.

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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

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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

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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

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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

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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

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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

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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

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Financial Data

• Balance Sheet
• Income Statement
• Cash Flow Statement

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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.

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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

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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

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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.

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• 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.

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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

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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.

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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.

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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.

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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

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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.

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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.

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ASSET, LIABILITY AND MARKET RISK
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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.

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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.

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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.

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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.

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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.

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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.

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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.

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CREDIT RISK

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

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CREDIT RISK
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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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