1. May 4, 2006 Iowa Actuaries Club “ What Every Actuary Should Know About Investing” Scott Christensen, FSA, CFA, MAAA Principal Financial Group Investment Actuary

2. 2 The Magic Letter “i” Traditional Actuarial Formulas –Future Value of an Annuity  FV annuity due = C * [ ((1+i) n – 1 ) / i ] * (1+i)  Etc. Inputs into Actuarial models (Excel, PTS, TAS, ALFA, MOSES, etc.) –Pricing Models –Projection Models –Etc. Applications

3. 3 Investment Return Assumption The investment return assumption is based on the investment portfolio used to back the liability This is calculated based on the composition of the investment portfolio Source Asset ClassYieldPortfolio Weighting Lehman U.S. Government5.17%10% Lehman ABS5.57%5% Lehman CMBS5.69%5% Lehman MBS5.97%15% Lehman Corporate5.99%50% Lehman Yankee5.78%15% Sample Investment Portfolio5.84%100%

4. 4 Default Rates Unknown Component to Investment Return Assumption

5. 5 Interest Rates Treasury Rates Unknown Component to Investment Return Assumption

6. 6 Corporate Spreads Historical Corporate Spreads Unknown Component to Investment Return Assumption

7. 7 Traditional Actuary vs. Investment Actuary Traditional Actuary –Mortality –Morbidity –Withdrawals –Casualty –Etc. Investment Actuary –Default/Recovery –Interest Rates –Spreads –Prepayment –Liquidity –Etc. Differences – Types of Risks

8. 8 Traditional Actuary vs. Investment Actuary Similarities – Methods for Dealing with Risk Investment actuaries take many of the same fundamental actuarial concepts and apply them to the Investment realm Some risks are included in pricing Capital held for unexpected losses Risk Mitigation “Bridge the gap” between the actuarial and investment professions

9. 9 Role of an Investment Actuary Typical Functions for Investment Actuaries –Provide pricing inputs for product actuaries to cover investment risks –Determine loss potential to calculate needed capital reserves –Evaluate earnings at risk –Calculate income statement volatility –Establish risk management processes to measure, monitor, and mitigate risks –Facilitate communication among the various business areas (investment professionals, risk management, product development, pricing, management)

10. 10 Keys to Success Expertise and credibility Model development Scenario generation Communication

11. 11 Keys to Success Elements of my personal educational and professional background that have been beneficial in my career: –Working with other Actuaries  5 years in product areas  FSA –Working with Investment Professionals  7 years in investments  CFA designation The combination of these types of skills allow an investment actuary to produce valuable information utilized in both investment decisions as well as the product pricing process Expertise and Credibility

12. 12 Keys to Success Actuarial Software Packages (PTS, ALFA, MOSES, TAS, etc.) –Building investment assets and derivatives to run in conjunction with liabilities –Building investment/disinvestment/derivative strategies –Projecting cash flows and earnings –Modeling a variety of economic scenarios –Utilize models for investment risk quantification/analysis Portfolio Credit Risk models –Model credit risk –Quantify correlations by securities  By issuer  By industry –Measure correlations between asset classes Model Development

13. 13 Keys to Success Your assessment of risk is contingent upon your estimation in the amount of risk in the underlying capital market variables Interest Rate curves, equity markets, fixed income indices, exchange rates, spread levels, implied volatilities, foreign capital markets, etc. Estimating the risk in capital market variables requires: –Disciplined process –Reliable historical data –Subjective evaluation and decisions Scenario Generation

14. 14 Keys to Success Clear and effective communication is vital in multiple situations –Presentations –One on one discussions –Recommendations and memorandums Communication with the various areas of the business –Investment professionals –Corporate actuaries –Product actuaries –Accounting professionals –Risk managers –Relationship managers All of these areas rely on the abilities of investment actuaries to aid in identifying, quantifying, and assessing investment risks Communication

15. 15 In Summary Investment Return is not a static assumption. Impacted by many unknown elements including defaults, future interest rates, etc. Current capital markets are not providing much compensation for taking investment risks. Companies are incented to take more risk to get more return. These investment risks need to be quantified. Investment actuaries take many of the same fundamental actuarial concepts and apply them to the Investment realm (pricing, capital requirements, risk mitigation, etc.) “What Every Actuary Should Know about Investing”

16. 16 Biography Scott Christensen- Investment Actuary Scott is currently serving as an Investment Actuary for Principal Financial Group. He has been with the company since 1994 and has served in his current role since 1998. Prior to his role with the Principal, Scott worked with the financial reporting area for the Group business unit as well as in the pricing area for the Pension business unit. He graduated from Nebraska with a BS in Actuarial Sciences. Scott is a Fellow in the Society of Actuaries, a CFA Charterholder and a Member of the American Academy of Actuaries.