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Asset Liability Management: Identifying and Managing Risk

Asset Liability Management: Identifying and Managing Risk. Chad Myers Vice President Asset Liability Management. Overview. Risk management philosophy affects nearly everything JNL does Product development Product pricing Investment strategy and implementation Hedging activities

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Asset Liability Management: Identifying and Managing Risk

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  1. Asset Liability Management: Identifying and Managing Risk Chad Myers Vice PresidentAsset Liability Management

  2. Overview • Risk management philosophy affects nearly everything JNL does • Product development • Product pricing • Investment strategy and implementation • Hedging activities • Emphasis on identifying risks and understanding them • JNL doesn’t take risks it can’t properly evaluate • Assumption of risk requires appropriate compensation • Deterministic vs. stochastic approach

  3. Approaches to Risk Management • Pricing • Structure • Reinsurance • Diversification • Hedging

  4. Fixed Annuities • JNL’s single largest product line • Third largest fixed annuity block in the U.S. • Spread-based • Contractual minimum interest rate is generally 3% • 92% of JNL’s book can be reset annually

  5. 8.0% 7.5% 7.0% 6.5% (%percent) 6.0% 5.5% 5.0% 4.5% 4.0% 05/04/00 06/04/00 07/04/00 08/04/00 09/04/00 10/04/00 11/04/00 12/04/00 01/04/01 02/04/01 03/04/01 04/04/01 05/04/01 06/04/01 07/04/01 08/04/01 09/04/01 10/04/01 11/04/01 12/04/01 01/04/02 02/04/02 03/04/02 04/04/02 05/04/02 06/04/02 JNL Max Plan Rate vs. Market Rates 8.0% 7.5% 7.0% 6.5% (%percent) 6.0% 5.5% 5.0% 4.5% 4.0% Highest Competitor 9 Yr Treasury Max New Money Competitor Average

  6. Fixed Annuity Interest Spread (Net Spread %) (Net Credited Rate %) 8.0% 8.0% 7.0% 7.0% 6.0% 6.0% 5.0% 5.0% 4.0% 4.0% 3.0% 3.0% 2.0% 2.0% 1.0% 1.0% 0.0% 0.0% Nov- Nov- Nov- Nov- Nov- Nov- May- May- May- May- May- May- May- Sep- Sep- Sep- Sep- Sep- Sep- Jul-97 Jul-99 Jul-96 Jul-98 Jul-00 Jul-01 Jan-96 Jan-97 Jan-01 Mar-97 Jan-98 Jan-99 Jan-00 Mar-01 Jan-02 Mar-02 Mar-96 Mar-98 Mar-99 Mar-00 Normalized Net Investment Spread Normalized Credited Rate

  7. Variable Annuities • Growing portion of JNL’s retail liabilities • Unit-linked deferred annuity contract • Performance in the underlying funds is passed onto the client • Asset based fees used to cover benefits /expenses • JNL has moved to an unbundled platform

  8. VA Guaranteed Benefits • JNL has chosen not to be a leader on guaranteed benefits • Aggressive benefits not adequately priced in market • Aggressive benefit built on unproven assumptions • GMDB • Main exposure is to 5% annual accumulation • Perspective II offers return of premium • Other options offered with appropriate charges • Not reinsured due to manageable mortality-based risk • GMIB • Only offered on unbundled basis • Must be elected at extra charge • Requires annuitization after 10 years • Benefit capped at 200% of premium • Reinsured due to uncertainty of utilization

  9. Perspective II Optional Benefits Elected: Year-to-Date September 2002 Benefit InitialPremium Percentage No optional benefits elected 71,338,166 13% 5% Compounded Death Benefit 107,163,001 19% Maximum Anniversary Death Benefit 59,720,935 11% Combination Death Benefit 90,830,651 16% Earnings Max 30,246,358 5% GMIB 145,244,111 26% 2% Premium Credit 23,902,163 4% 3% Premium Credit 12,957,713 2% 4% Premium Credit 238,462,750 42% 20% Free Partial 26,691,070 5% 5 Year Withdrawal Charge 31,458,968 6% Year-to-Date Issues September 2002 562,564,441 100%

  10. Equity Index Annuities • Hybrid of variable annuity / fixed annuity • Greater of: • 90% of the premium accumulated at 3% or… • Percentage of the gain in the S&P 500 • Simple design, easy to hedge • Options bought to cover the equity portion • Fixed income invested to provide minimum guarantee • Spread-based

  11. Life Insurance • Not primary focus over last several years • Maintain $5 billion in life insurance liabilities • Term and Interest Sensitive Life • Mortality on term locked in at time of sale due to 90% quota share arrangement • Interest Sensitive Life pricing has spread and mortality gains to cover benefits and expenses

  12. Statutory Reserves – Major Product Categories Category 12/31/96 6/30/02 Amount % Amount % Annuities with Book Value Surrender $15,844 64.0% $13,830 33.0% Annuities with MVA 1,863 7.5% 4,949 11.8% Equity-Linked Index Annuities 34 0.1% 2,466 5.9% Other 733 3.0% 1,327 3.2% Total General Account Annuities $18,474 74.6% $22,572 53.9% Life Insurance 4,494 18.1% 5,053 12.0% Institutional Products 1,464 5.9% 9,786 23.4% Total General Account $24,432 98.6% $37,411 89.3% Separate Account (VA) 345 1.4% 4,463 10.7% Total Reserves $24,777 100.0% $41,874 100.0% Data is consolidated to include Jackson National of New York.

  13. JNL Risk Profile • Three main product types • Fixed annuities / Institutional (spread-based) • Variable annuities (fee-based) • Life insurance (hybrid of spread and mortality)

  14. JNL Spread Business Basics • JNL issues contracts with initial crediting rates subject to reset • Policies are subject to surrender charges • Long-term rate guarantees are further subject to market value adjustments • Assets are invested in a diversified pool of mostly fixed income assets to earn a spread

  15. Risk Inherent in Spread Lending Businesses • Interest rate risk • Spread risk • Credit risk • Liquidity risk

  16. Interest Rate Risk • Rate movements cause changes in the value of assets and liabilities • Where sensitivities are materially different, rate changes will cause economic gains or losses • Significant rate increases - book value surrenders • Significant rate drops - minimum rate guarantees

  17. JNL Approach to Interest Rate Risk • General risk mitigation • Option adjusted pricing • Surrender charges • Product diversification • Increasing rates • Swaption program • Market value adjustments • Decreasing rates • Product specific investment guidelines • Annual resets on fixed annuities

  18. Spread Risk • Profitability depends on • Ability to achieve pricing spreads • Spreads can be affected by • Reinvestment risk • Embedded options in assets/liabilities • Equity return assumptions • Investment lag • Lost coupon income • Expense variances

  19. JNL Approach to Spread Risk • Focus on annual reset products for fixed annuities • Match assets and liabilities • Low exposure to equity/property • Risk adjusted return assumptions • Strong expense discipline

  20. Credit Risk • At its core the spread-based business relies on a credit arbitrage • Issue contracts based on high credit rating • Invest in lower-rated credits to earn a spread above issuance cost • Hold adequate capital to allow for risk • The main question is how much risk to take? • Higher-risk assets provide higher spreads, but increase capital needs and credit risk • Lower-risk assets have lower capital needs and credit risk but provide lower spreads

  21. JNL Approach to Credit Risk • Balance trade-off between risk and yield • Capitalize the company to a level appropriate for the level of risk • Evaluate all investments net of expected long-term default cost • Rigorous credit evaluation process • Well-diversified portfolio • JNL establishes policy, PPMA implements

  22. Liquidity Risk • Liabilities provide for varying degrees of liquidity • Medium-term notes, Single Premium Immediate Annuities – no liquidity • Fixed annuities offer liquidity with varying surrender penalties • Retail policies tend to be “sticky” • Due to surrender charges and inertia • Institutional holders exercise options very efficiently • Asset liquidity must reflect potential liability demands

  23. 2.5x $20,000 2.3x $18,000 2.0x $16,000 1.8x $14,000 1.5x $12,000 Excess Liquidity ($millions) Coverage Ratio Multiple 1.3x $10,000 1.0x $8,000 0.8x $6,000 0.5x $4,000 0.3x $2,000 0.0x $0 Jul-99 Jul-00 Jul-01 Oct-98 Jan-99 Feb-99 Mar-99 Jun-99 Oct-99 Jan-00 Feb-00 Mar-00 Jun-00 Oct-00 Jan-01 Feb-01 Mar-01 Jun-01 Oct-01 Jan-02 Feb-02 Mar-02 Jun-02 Nov-98 Dec-98 Sep-99 Nov-99 Dec-99 Sep-00 Nov-00 Dec-00 Sep-01 Nov-01 Dec-01 Apr-99 Apr-00 Apr-01 Apr-02 May-99 Aug-99 May-00 Aug-00 May-01 Aug-01 May-02 Excess liquidity-30 day horizon JNL Approach to Liquidity Risk JNL Liquidity Analysis * Excess liquidity-1 year horizon Coverage ratio-30 day horizon Coverage ratio-1 year horizon * Ratio of Available Assets to Potential Obligations

  24. Variable Annuities • Fee-based business • Main drivers of profitability are determined at pricing • Earnings variability driven by: • Equity returns • Guaranteed benefits • Expenses

  25. Life Insurance • Spread and mortality based business • Spread component similar to fixed annuities • Mortality component managed through reinsurance • Lock in mortality assumptions at policy issue

  26. Where Does JNL Stand? Hedge Analysis 110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Pop Pop Pop Level Pop Up Pop Up Pop Up Pop Up Pop Up Pop Up Pop Up Down Down Down 1% 2% 3% 4% 5% 6% 7% 3% 2% 1% Rate Scenario Unhedged Hedged

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