2008 General Meeting Assemblée générale 2008 Toronto, Ontario 2008 General Meeting Assemblée générale 2008 Toronto, Ontario Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Variable Annuity Background Popularity from preferential tax treatment Basic return of premium GMDBs Increasingly richer guarantees – Annual ratchets, Roll-ups, $-for-$ withdrawals Market drop highlighted risks inherent in guarantees – Regulators, auditors focused on embedded risks – Hedging programs developed and implemented Recent developments – Emphasis on living benefits to meet retirement income needs – Hedging becomes standard industry practice – Better understand risks and charge appropriately

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Variable Annuity Evolution Product innovation has been significant since the adoption of risk management through hedging SOPHISTICATIONSOPHISTICATION ROP GMDB Enhanced GMDB (annual Ratchet 5% roll-up) GMIB GMAB GMWB EIA GMWB / AB Combo GMWB for life With Ratchet Joint Life GMWB

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Current Variable Annuity Trends GMWB most popular of GLBs Latest Product is Lifetime GMWB – New filings have increased dramatically – Policyholders are guaranteed withdrawals after the remaining balance reaches zero – Liquidity via full access to cash value – Allows more equity allocation rather than more conservative fixed asset allocation

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 GMWB Product Variations Withdrawal Percentage (5-7%) – Constant – Based on age at first withdrawal Ratchet frequency (annual to 5 year) Bonus (5%-7%) applied to guarantee value for each year withdrawals delayed Rider Charge base (40-75bps) of Account Value, Guaranteed Remaining Balance, or Guaranteed Base Spousal continuation Asset Allocation restrictions Issue age restrictions Lifetime GMWB – Guaranteed maximum of 5% withdrawal a year for life

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Variable Annuity Management Risk Management Objectives Risk Management Strategy Product Design and Pricing

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Risk Management Objectives Economic Risk – Hedge risks that impact actual claims Financial Statement Risk – Reduction in quarterly Profit and Loss Risk–neutral vs. Real-world Capital Reduction Source: Moody’s Survey

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 ObjectiveCompany EconomicUS Mutual companies International companies following IFRS or Canadian GAAP StatementPublic US Companies CapitalCurrently not a primary focus Current Trends

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Current Market Implications Companies re-evaluating the cost / benefits of managing accounting risk Risk with the guarantee is high realized volatility – Implied volatility theoretically the market’s view of future realized volatility – Theory deviates for long term options Long term option market is fairly illiquid, driven by supply / demand imbalances – Demand driven by VA hedging programs – Supply has reduced due to current credit crisis Full market consistency may not be available for insurance liabilities as insurance guarantees are illiquid and long term

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Risk Management Strategies Naked - capital pays for claims Semi-Static - buy and hold using a portfolio of options Dynamic - manufacture risk management internally Static - exotic derivative to manage capital market risk Reinsurance - mitigate capital market and actuarial risks Source: Moody’s Survey

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Current Trends Industry trend towards dynamic hedging – Uses vanilla, liquid instruments resulting low transaction costs – Hedge positions are continuously updated to reflect policyholder experience – Minimal transaction costs incurred from adjusting hedge positions to prospective changes in assumptions – Becoming industry standard practice with best practices evolving – Regulators and rating agencies recognizing dynamic hedging as risk mitigating techniques

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Stress Testing Hedge Performance Companies should test strategies before implementing them. – Hedging is not risk free. Each strategy has its own risk-reward profile. Testing helps develop this understanding. – Need to know what types of market environments will be problematic for any given strategy. – Stress Testing: Need to know how strategy will perform over extreme market scenarios – Senior management must be comfortable with the risk exposures associated with the strategy This requires developing strategy simulation capabilities – Stochastic on Stochastic – Short time-step – accurately reflect actual rebalancing approach – Full projection of liability evolution over time as well as hedge transactions

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Financial Projections Used to Evaluate Risk & Profitability

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Strategy Testing

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Product Pricing Value using risk-neutral valuation which measures the cost of hedging – Guarantee is a financial derivative – Industry standard practice – Reinsurer’s are also pricing on a risk-neutral basis

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Current Market Implications Current environment has stressed pricing – High implied volatilities and low interest rates – Current products have not fully reflected new capital market environment – Higher charges or lower benefits required Decisions for next round of pricing – Capital markets are always changing, while rider pricing is less frequent – Current capital markets vs. a long term view – Long term view may result in mis-pricing over different periods Right to increase charge on reset – Companies have started to exercise this right

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Product Design Lack of credible policyholder behavior experience – Understand and sensitivity test key assumptions – Conservatism in pricing – Design products to mitigate adverse behavior – Monitor experience

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Current Market Implications Consider risk management in product design – Asset allocation restrictions – Withdrawal rates linked to treasury rates – Adjusted withdrawals rates for early withdrawals – Using index funds reduces basis risk

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Reporting & Monitoring Performance Attribution Hedge Effectiveness Performance Measurement

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Performance Attribution Market Attribution – Impact of Hedged Indices (delta hedging) – Performance of Unhedged Indices – Net Impact of Interest Rates (rho hedging) – Net Impact of Implied Volatilities (vega hedging) Time Decay Lapse/Death Impact Basis Mismatch Asset Allocation Transfer Impact Net Deposits Impact New Business Impact

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Hedge Effectiveness Breakdown change in assets and liabilities due to changes in capital market factors Capital Market Factors – Equity Index Movements – Interest Rates – Implied Volatilities

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Hedge Effectiveness 9/1 – 10/31 All company results are normalized to $1billion as of 8/29/08

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Performance Measurement Measurement & Attribution Analysis – Tracking Income Slippage And Model Error – Granularity Of Attribution Analysis Management Of Tracking Error – Portfolio Level – Fund Level – Risk Driver (Greek) Level

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Performance Reports provide clear indication should problems in a program manifest themselves Hedge Performance Report

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Tail risk is an essential element of the risk communication Hedge Program Risk Report

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Thank-you Contact – Milliman (Financial Risk Management) – –