Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2009 Session PD-4: The New World of Risk Management for Variable Annuities and Segregated Funds Frank Zhang, CFA, FRM, FSA, MAAA, PRM Executive Director VA Financial Risk Management and Hedging Advisory Practice Leader Ernst & Young LLP, New York Séance TR-4 : Le nouveau domaine de la gestion du risque pour les rentes variables et les fonds distincts

2 Agenda Events since 2008 – Capital market disruptions – Segregated fund/variable annuity losses New areas of focus – Robust hedging program – Advanced financial modeling – Integrated financial risk management and pricing – Hedging strategy best practices 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

3 Capital market disruptions What has happened since 2008: – Normality — what’s normal? – Liquidity — what liquidity? – Volatility — what volatility? Could this happen again? – Market fall another 50%? 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

4 Segregated fund and VA losses Segregated fund and VA losses: – Capital squeeze from general account investment losses – Tracking errors — what errors? – Marked-to-market losses — short-term or real? – Trading losses — buy high and sell low? Effectiveness of risk management: – Hedged and unhedged – Market and actuarial – Is it clear who is responsible for everything? 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

5 Events since 2008 – Capital market disruptions – Segregated fund/VA losses New areas of focus – Robust hedging program – Advanced financial modeling – Integrated financial risk management and pricing – Hedging strategy best practices Agenda 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

6 New areas of focus Robust hedging program Advanced financial modeling Integrated financial risk management and pricing Hedging strategy best practices 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

7 Robust hedging program Gold standard operation/process controls and risk management framework: – Banks versus insurers Hedging performance is now a critical component of a company’s financials: – New Board-level concerns – Is your program (or product) too complex for the CEO to understand? Robust hedging P/L performance attribution: – Know why, so problem areas can be fixed Reporting and transparency 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

8 Advanced financial modeling Gold standard modeling tools Continued improvements in research Principles-based valuations/reporting Nested stochastic simulations Watch out for garbage in/garbage out 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

9 Integrated risk management and pricing Gold standard pricing methodology Start with the fundamental — pricing Focus on underlying funds first Integrate capital market inputs in pricing Apply robust risk management techniques 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné

10 Hedging strategy best practices Gold standard of risk management strategies – Greeks based versus the new mix of new metrics Determine trade-offs between: – Earnings volatility and capital optimization – Marked-to-market P/L (forward-looking implied or expected volatility) and trading P/L (realized volatility) Identify implied risky bets Link pricing with hedging Know your options: – Before you need them – When things are normal 2009 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné Seminar for the Appointed Actuary Colloque pour l’actuaire désigné