Agenda

1. Variable Annuity IndustryChallenges and OpportunitiesCanadian Institute of Actuaries - 2009 General MeetingPD-7 Hedging VA/Seg Fund Products November 19, 2009Financial Risk ManagementMilliman, Inc.

2. Agenda Valuation Methodology Risk Management Strategies Impact of Financial Crisis VA Hedging Programs Innovations in Product Design Future Outlook

3. Valuation Methodology - US GAAP • US GAAP Methodology • Valuation methodology varies based on the type of guarantee • Non-life contingent guarantees (GMWB, GMAB, partial GLWB) • Risk-neutral valuation under FAS 133/157 • Sensitive to changes in equity markets, interest rates and implied volatility • Life contingent guarantees (GMDB, GMIB, partial GLWB) • Real-world with smoothing (SOP 03-01) • Partial sensitivity to changes in equity markets • Base product revenues and expenses are earned as operating income (net of DAC amortization) • Impact on hedge strategy • FAS133/157 : Encourages delta-rho-vega hedging • SOP03-01 : Encourages partial delta hedging

4. Valuation Methodology - STAT Capital • Statutory Capital (RBC C3 Phase II) • All guarantees are treated equivalently • Incorporates base product revenue and expenses • Projection on a real-world basis • Hedge credit for company’s specific hedge program • Standard scenario impacts may dominate in certain scenarios • Impact on hedge strategy • Encourage delta hedging • Mean reversion embedded in scenarios discourages rho hedging (in current market environment) • Historical calibration discourages vega hedging • Incorporation of hedge credit makes capital sensitivity neutral to vega and rho hedging

5. Valuation Methodology - STAT Reserve • Statutory reserving (VACARVM AG-43) counterpart to RBC C-3 Phase II • Like C-3 Phase II, AG 43 represents a step closer to a principles-based approach • Adopted by the NAIC in Sept 2008 • Replaces AG 34 (GMDB) and AG 39 (GLB) reserving methodologies as of 12/31/2009 • (A slight variation of) AG 33 still used to calculate the Basic Adjusted Reserve component for the Standard Scenario • If AG 43 produces higher reserves than was the case under prior statutory guidelines, a grade in period of (not to exceed) 3 years may be requested

6. AG-43 vs. C-3 Phase 2

7. AG-43 vs. C-3 Phase 2

8. AG-43 vs. C-3 Phase 2

9. AG43 needs to be managed differently from C3P2 • Captive off-shore reinsurance and hedging had been effective and popular tools in managing C3P2 • Better yet, use the captive off-shore reinsurance company as the hedging operation center • The two approaches may face challenges in AG43 • Reinsurer needs to show assets backing reinsurance credit for ceding company • Hedging credit may not reduce AG43 amount much

10. Impact of AG43 Implementation for Year End 2009 • There is no simple “rule-of-thumb” for the impact of AG43 for year-end 2009 • Too many factors affecting the results between CTE(70) and standard scenario amounts and between AG43 and current reserve held • Examples of factors affecting CTE(70) vs. SSA - Base product fees - Base product surrender charge schedule - Actual guarantee charges - Policy duration - Moneyness - Policyholder behavior assumptions • Examples of factors affecting AG43 vs. current reserves • Cash flow testing methodology • Year end actual capital market conditions • Policy duration

11. Stay Naked Assume enough capital pays for claims Semi-Static Buy and hold using a portfolio of options Dynamic Need to manufacture the risk management internally Static Exotic derivative to manage capital market risk Reinsurance Mitigate capital market and actuarial risks Source: Moody’s Survey Risk Management Strategies

12. Risk Management Strategies - Trends • Industry trend towards dynamic hedging • Effective in mitigating risk • 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

13. Risk Management Strategies - Trends • Static hedging • Increased product innovation • Basket lookback options • Levered equity options with higher payouts in low interest rate environments • Full cashflow matching structures • Minimal adoption • High transaction costs • Doesn’t protect against policyholder behavior risk • Companies that transitioned away from static customized hedges : Importance to follow on industry standard practices • Reinsurance availability? • As the volume of guarantees increase, a combination of strategies will be employed

14. Impact of Financial Crisis

15. US VA Market Overview About $1.3 trillion asset under management as of year end 2008 96% offer living benefit guarantees * Distribution of living benefits are roughly * *Source: Milliman 2009 GLB survey

16. The Recent Financial Crisis has been Severe Failure of well known financial institutions Lehman Brothers, Merrill Lynch, Bear Stern Credit risk is brought to the fore Worldwide decline in equity market Rapid reduction of interest rates Increased volatility

17. Impact of Financial Crisis • Insurance industry was materially impacted by recent market events • Primary drivers were asset impairments and Variable Annuities • Variable annuity guarantees were highlighted • Key drivers of losses related to VA’s • DAC unlocking on base product • Basis risk on actively managed funds • Exposure from un-hedged guarantees • Hedging of in-force guarantees was fairly effective • Milliman survey results showed approximately 94% effective between Sept 2008 to March 2009 • Costs of issuing new guarantees have increased substantially • Costs are typically higher than rider charges

18. Insurance Industry View on VAs • Variable Annuities and guarantees continue to be a vital part of the insurance industry • Pure protection business is still important, but asset accumulation & income products dominate sales • VA guarantees differentiate life insurance companies from mutual fund companies and banks • Guarantees still provide customers with a good value proposition • Global opportunities • Creating a sustainable VA business model requires • 1. Product Design innovation • 2. Re-evaluation of hedge objectives • 3. Improvements to hedge program and operations

19. VA Hedging Programs

20. Hedge Program Objectives • Hedge programs could have conflicting objectives • Selection of hedge program objectives reflects management risk preference and appetite • Trade-offs of objectives are often needed • Fair value protection has historically been most common • Capital protection and macro-hedging gain popularity recently

21. Hedge Strategies • Almost all use a dynamic hedging strategy • More sophisticated companies opportunistically use a combination of strategies • Almost all companies incorporate a delta hedging strategy. • Some also layer on rho and vega hedging strategies • 69% of respondents do not hedge all exposures

22. Hedge Objectives • Historically hedge objectives focused on managing quarterly GAAP earnings volatility • Fully hedge equity, interest rate and volatility risk of GMAB, GMWBs and a portion of Lifetime GMWB • Partially hedge equity exposure of GMDB, GMIB and life-contingent portion of Lifetime GMWB • There are often conflicts between objectives in US GAAP and economic fundamentals • Recent events have brought more focus on statutory balance sheet • Severe market events have caused companies to shift focus to solvency • New statutory capital and reserve methodologies are more market sensitive

23. Macro / Capital Protection Hedge • Solution has been to overlay a Macro / Capital Protection hedge above core strategy • Complex problem with many dimensions • Different ways to approach it: • Explicitly hedge capital sensitivity • Requires revaluation of capital sensitivity and existing hedge program • Captures detailed dynamics and non-economic behavior (standard scenario, VA-CARVM etc.) • Defining a more transparent and easy to calculate target • Defining as package of options • Directly hedging guarantee benefits not included in core strategy • Using a deductible approach on guarantee benefits

24. Hedge Effectiveness Results in Two Studies • Milliman conducted two studies of hedging program effectiveness during the turbulent period between September 2008 and March 2009. • Milliman found the average effectiveness to be 93% during September 2008 and October 2008 • S&P decreased 24.5% from 1283 to 969 • Very rapid movements • Realized volatility as high as 60% • Milliman found the average effectiveness to be 94% between November 2008 and March 2009 • S&P decreased 17.6% from 969 to 798 • Market shown more stabilized decline • Hedge effectiveness is defined as (hedge asset payoff) / (liability fair value increase due to hedged risks)

25. Bifurcation of Hedging Results • Bottom line : How much a hedging program has recovered total losses? • Question 1: How effective is the hedging program in recovering losses it is designed to cover? • Question 2: How much loss is not covered by a hedging program? • Milliman’s studies covered the first question, and not the second one. • It is critical to distinguish these two questions

26. What Has Worked Insurance company hedging programs are designed to reduce the exposures to capital market risks Do not take risks to make a profit Use simple hedging instruments Futures contracts Plain vanilla options Little counterparty risk Be highly transparent Open discussion of hedging methodologies Reviewed and audited by multiple parties Contained operational risks

27. What Hasn’t Worked Leave critical exposure unhedged Follow accounting peculiarities blindly US GAAP SOP03-1, Canadian GAAP are not fair valued Following non-fair value accounting rules blindly hurt the economic fundamentals Deviate from sound risk management principles Under pricing Unchecked fund allocation Keep hedging practice as a secret Leaving blind spots in hedging programs Basis risk must be controlled

28. Enhancements to Hedging Programs Basis risk management Expanding hedging program to uncovered risks Macro hedging

29. Expand Hedge Instrument Universe & Adopt 24 Hour Market Coverage Risks: EQUITY S&P 500 Russell NASDAQ DJ Industrials Canada S&P TSX DJ Eurostoxx 50 FTSE Nikkei Topix Hang Seng Hang Seng China Enterprise Korea Kospi Taiwan TWSE India Nifty Brazil Bovespa Emerging Markets Australia S&P ASX 200 INTEREST RATES Canadian Interest Rates Euro-zone Interest Rates UK Interest Rates Swiss Interest Rates Japan Interest Rates CURRENCY CROSSES On Rate Pairs From Above • Contracts: • Equity Index Futures • Equity Total Return Swaps • Interest Rate Swaps • Interest Rate Futures • Swaptions • CMS/Libor caps/floors • Volatility Futures • Variance Contracts • OTC Equity Options • Exchange-traded equity options • Hybrid derivatives • Inflation Swaps • Fixed Income Total Return Swaps • Credit-Related Swaps • Currency Forwards • Currency Futures

30. Innovations in Product Design

31. Milliman Hedge Cost Index • The overall cost of hedging has increased substantially

32. Latest Trends in VA GLB – Late 2008 To 2009 • With effective date through mid May09, 33 VA writers filed changes on 125 existing products; 8 VA writers filed 12 new products. • Summary of 2009 VA product changes: • Summary by nature of changes • Summary by number of changes

33. Industry Trends • Filing requirements provide some flexibility for minor product changes, major product changes require re-filing • The more immediate changes are: • Rider Fees : Increases between 15-30bps on both existing and new business • Withdrawal Rates • Increased earliest withdrawal age to 65 • Adjusted age bands, still 5% at age 65 • Reduction in features • Removal of “doubler” • Reduced bonus rates, typically 1-2% reduction • Reduced length of bonus period or age restrictions • Asset Allocation • Removal of most aggressive asset allocation model • Use of more index funds

34. Product Design • Design changes to date have been incremental adjustments to current products • Next generations of designs should consider: • Guarantees that adapt to capital market conditions • Including hedges inside separate accounts • Asset allocation models that target a specific volatility • Revaluate compensation structure

35. Existing VA Business Model Funds Stocks Insurer Balance Sheet ■Guarantee Liability ■Hedge Assets ■P&L Volatility Guarantee Fee Bonds

36. Sustainable VA Business Model Funds Insurer Balance Sheet ■Reduced & Stabilized Guarantee Liability ■Reduced P&L Volatility ■ Transfer of Hedge Breakage & Basis Risk to Policyholder ■ Reduced Behavior Risk Stocks Reduced Guarantee Fee Bonds & Hedges

37. Asset Allocation Models – Current Approach • Asset allocation models are widespread in the VA market • Typically: Conservative, Moderately Conservative, Moderate, Moderately Aggressive, Aggressive • Each model targets a specific equity allocation (ie 20, 40, 60, 80, 100%) • Current models do not consider VA hedging programs • Quarterly model updates lead to GAAP income volatility for VA writers • This approach exposes VA writer to material P&L volatility • Increases in implied volatility

38. Asset Allocation Models – Alternative • Conservative, Moderately Conservative, Moderate, Moderately Aggressive, Aggressive models constructed to target a specific risk level • Target a constant volatility level for the account value • Much better integration with VA hedging programs • Volatility target used directly in GAAP reserve calculation • Asset allocation process reflected in VA-CARVM & RBC C3P2 calculations • Stabilizes statutory reserves and capital • Eliminates exposure to implied volatility • Reduces cost of VA hedging programs via elimination of OTC risk margin

39. Comparison of Asset Allocation Models

40. Vol-of-Vol Reduced by 52%

41. Move Hedges into Customer AccountA Sustainable Manufacturing Process • Embedded derivative largely disappears from insurer B/S • Quarterly P&L volatility is dramatically reduced • Customer owns the hedges • Hedges are an asset allocation choice, NOT expressed as a fee • Customer’s account value is supported during market declines • Basis risk & other hedge noise is absorbed in the customer account value • Actively managed funds work well under this approach • Behavior risk is dramatically reduced • Process accommodates full spectrum of guarantee designs • Guarantee fee is reduced & stabilized

42. Future Outlook Key Risks In the VA Industry • Sustained decline in equity market • Increase in interest rates leading to disintermediation • Irrationally rich benefits for better market share • High rollup rates • Policyholder behavior risk • Lapse assumption not materializing • Underpriced products requiring large capital causing long term low ROE • Hedging programs can only protect risks in the future

43. Milliman, IncFinancial Risk Management71 S. Wacker Drive, 31st Floor Chicago, IL 60606Ph: +1 312.726.0677Fx: +1 312 499.5700www.milliman.com