Impact of low interest rates on life insurance industryActuaries Club of Philadelphia – annual meeting

February 12, 2013

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BACKGROUND

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How low are rates?

► Average 30-year mortgage rate in 20121:

3.66%

► Annual money market yield in 20122:

0.04%

1Source: Associated Press. “30-year mortgage rate rises to 3.42%.” USA Today. January 24, 2013. http://www.usatoday.com/story/money/business/2013/01/24/mortgage-rates/1861865/2Based on Vanguard Prime Money Market return in 2012: (https://personal.vanguard.com/us/funds/snapshot?FundId=0030&FundIntExt=INT#tab=1)

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CAUSES

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Federal Funds Rate

Source: “Effective Federal Funds Rate (FEDFUNDS).” Economic Research Federal Reserve Bank of St. Louis. February 7, 2013. http://research.stlouisfed.org/fred2/series/FEDFUNDS

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Federal Open Market Committee (FOMC)

“…the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent…”

- FOMC Press Release, December 12, 2012

Source: “Press Release.” Board of Governors of the Federal Reserve System. December 12, 2012. http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm

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Source: O’Brien, Matthew. “The 1 Thing the World’s Smartest People Don’t Get About the Fed.” January 4, 2013.http://www.theatlantic.com/business/archive/2013/01/the-1-thing-the-worlds-smartest-people-dont-get-about-the-fed/266812/

Quantitative easing (QE)

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Investing trends

Source: “Flows and Liquidity.” Global Asset Allocation. JP Morgan. January 11, 2013.https://mm.jpmorgan.com/EmailPubServlet?h=129diuua&doc=GPS-1025162-0.pdf

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IMPACTS

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Collateral damage

Source: Shilling, A. Gary. “Who Loses When the Fed Keeps Interest Rates Low?” Bloomberg. October 30, 2012.http://www.bloomberg.com/news/2012-10-30/who-loses-when-fed-keeps-interest-rates-low-.html

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Impact on stock prices

Source: “Facing the Interest Rate Challenge.” Swiss Re Sigma. 2012. http://media.swissre.com/documents/sigma4_2012_en.pdf

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Source: “Low Interest Rates and the Implications on Life Insurers.” NAIC CIPR Newsletter. April 2012.http://www.naic.org/cipr_newsletter_archive/vol3_low_interest_rates.htm

Product-specific impacts

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Source: “Actuarial Standard of Practice No. 10.” Actuarial Standards Board. March 2000.http://www.actuarialstandardsboard.org/pdf/asops/asop010_068.pdf

Financial reporting impacts

“In instances where GAAP requires best-estimate assumptions, the actuary should choose assumptions that, in his or her judgment, reflect the most likely outcome of events…Relevant accounting standards call for best estimate assumptions to be periodically reviewed and updated to reflect emerging experience”

- ASOP 10, Methods and Assumptions for Use in Life Insurance Company Financial Statements Prepared in Accordance with GAAP

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MITIGATION

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Reaching for yield

“However, a more disturbing effect of the lower bond yields is that they may have induced a growing appetite for risk. In the case of insurance companies, with contractual obligations to pay high rates of return on their liabilities, such behaviour became almost a matter of survival.”

- BIS 74th Annual Report, June 28, 2004

Source: “BIS 74th Annual Report”. Bank of International Settlements. June 28 2004. http://www.bis.org/publ/arpdf/ar2004e1.pdf

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Investing trends

Source: “Seeking Return in an Adverse Environment, Insurance CIO Survey”. Goldman Sachs Asset Management. July 2012.http://www.goldmansachs.com/s/GMeT_othermailings_attachments/6347837329351787503251.pdf.

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Hedging

“The interest rate scenario we discussed last fall assumed a rate curve with a 10-year Treasury rate held flat at 2% for 5 years. We reran that scenario using a more recent yield curve with a 10-year Treasury at a record low 1.4%. The result was essentially no incremental impact on MetLife's earning per share for 2012 and 2013 and only roughly $0.05 per share in 2014.”

- Steve Kandarian, CEO, MetLife

Source: Armistead, Tom. “MetLife: Low Interest Rates Are Not A Problem.” Seeking Alpha. August 3, 2012. http://seekingalpha.com/article/779731-metlife-low-interest-rates-are-not-a-problem

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Hedging interest rate risk

88%

increase in the notional amount of interest rate hedges from 2010 to 2011

Source: “NAIC Capital Markets Weekly Special Report.” NAIC. January 9, 2013. http://www.naic.org/capital_markets_archive/130109.htmSource: “NAIC Capital Markets Weekly Special Report.” NAIC. June 10, 2011. http://www.naic.org/capital_markets_archive/110610.htm

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Source: “Lincoln National Management Discusses Q3 2012 Results – Earnings Call Transcript.” Seeking Alpha. November 2, 2012.http://seekingalpha.com/article/973701-lincoln-national-management-discusses-q3-2012-results-earnings-call-transcript?part=single

Product allocations

“Our pivot to the sale of higher return products like Variable Universal Life, Indexed Universal Life and term insurance grew 23% from a year ago. These products now comprised 32% of our total Life sales while GUL accounts for just 22%.”

- Dennis Glass, CEO, Lincoln National Company

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FUTURE

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The “Great Rotation”

“I think the 'great rotation' has already started in terms of flows and returns”

- Michael Hartnett, Chief Investment Strategist, BofA Merrill Lynch Global Research

Source: Aneiro, Michael. “Again With The ‘Great Rotation’: Signs Of Shift Out Of Bonds?” Barron’s. January 14, 2013. http://blogs.barrons.com/incomeinvesting/2013/01/14/again-with-the-great-rotation-signs-of-shift-out-of-bonds/

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Source: “Daily Treasury Yield Curve Rates.” US Department of the Treasury. 2013.http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2013.

Potential Treasury spike

1/2/2013 1/7/2013 1/12/2013 1/17/2013 1/22/2013 1/27/20131.80%

1.85%

1.90%

1.95%

2.00%

2.05%

10-year Treasury yields in January 2013

Treasury spike in late January

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QUESTIONS