Panel Discussion on Volatility Management of Equity-Based Insurance Guarantees

Tuesday’s last session of the day covered “Volatility Management of Equity-Based Insurance Guarantees.” The panelists included:  Pin Chung, CFO and CIO, R+V International Business Services Ltd; Philippe Combescot, Head of Americas Equity Derivatives Structuring & Strategy, BNP Paribas; Stefan Jaschke, Head of Quantitative Methods, Munich RE; and Andrew Rallis, Senior Vice President & Global Head of Asset/Liability Management, MetLife.

Pin Chung presented an introduction to equity-based insurance guarantees (EBIGs).  From the policyholder point of view, EBIGs should feature: simple product design to secure the value of investments; meaningful protection to mitigate factors such as market, inflation and longevity risks; reasonable liquidity; a fee level that reflects riskiness; easy to adjust portfolio; transparent exposure levels; possibility to pay additional irregular premiums; and a user-friendly interface to monitor and manage policy.

From an insurance company point of view, EBIGs are structured with: reasonable profitability and sustainable competitiveness; hedgable guarantee; unhedgable risks are manageable; avoidance of anti-selection; reasonable incentive to agents and customers; creation of a long-term relationship with policy holders; agents understand the product; minimizing market conduct risk; and select and adapt level of flexibility offered to policy holders.

Andrew Rallis spoke about the option-like nature of variable annuities.  He noted that small product variations can drive big changes in strategy.  To mitigate risk, variable annuity writers normally use dynamic hedging, underhedging, or static hedging with vanilla puts.  Managed volatility funds were designed as a response to address these issues.

Philippe Combescot covered the volatility profile of EBIGs.  He noted that insurance companies are required to publish their derivatives exposure.  Insurance companies are the largest buyers of long term SPX volatility.  The standard hedging instrument is a SPX vanilla put. Hedging activity has increased since 2009, with insurance companies buying $75M vega of long term SPX puts (maturity from 5 to 10 years).

Stefan Jaschke spoke on life insurance product design and hedging.  In product design, the three steps include defining the investment building blocks, choosing the term profile and determining the level of guarantee. Key issues to consider include the credit risk of the base guarantee borne by the policyholder; flexibility while avoiding costly policyholder options and can the upside be constructed and valued easily and with low transaction costs.