Life Insurance Companies Indicate the Need to Improve Their Risk and Capital Management Practices, According to Tillinghast Survey

New York, NY, October 16, 2002 � According to the just-completed Tillinghast � Towers Perrin (Tillinghast) survey of Chief Financial Officers (CFOs) of North American life insurers, companies are giving higher priority to their risk and capital management practices.

These findings are consistent with Tillinghast’s observations that external pressures are causing life insurers to increase their emphasis on effective approaches for measuring, reporting and managing earnings volatility and key financial risks. Some of the external pressures include:

  • increased scrutiny on companies’ financial results by regulators, rating agencies, analysts and key stakeholders
  • continuing volatility and downturn in equity markets
  • impending changes in risk-based capital requirements, and
  • a general lack of reinsurance capacity and coverage for guarantees on equity-based products.

This survey was the second in a series of Web-based “pulse” surveys of North American life insurance CFOs, conducted by Tillinghast, the global actuarial and management consulting firm. This installment examined issues relating to risk and capital management practices. In particular, the survey focused on how insurers are responding to volatile capital markets and proposed regulatory changes that have brought an increased focus on risk and capital management practices.

Need for an Increase in the Use of Financial Modeling to Analyze Earnings Volatility

Although most survey participants are conducting one or more types of scenario testing to analyze future earnings volatility, many are focused on less sophisticated approaches, such as selective stress testing of assumptions. Only about a third (37%) of all companies are analyzing earnings volatility on a total company basis using extensive scenario testing.

While companies’ current use of scenario testing is primarily to comply with regulatory requirements (57%), two thirds of all respondents are considering increasing the degree to which they use scenario testing to address internal needs of senior management and to enhance the strategic decision-making process.

“It is vital for companies to broaden their use of extensive scenario testing and embed it into the strategic decision-making process. This will allow companies to create a more direct link between risk and value and to better understand future earnings volatility. Using scenario testing solely to meet regulatory requirements is inadequate in today’s demanding business environment, where internal and external pressures on CFOs to mitigate unexpected surprises in earnings have increased dramatically,” said Jack Gibson, Tillinghast’s Life Sector Leader for North America.

Proactively Managing Risks Associated with Equity-Based Products

Over three quarters (80%) of respondents to the CFO survey currently offer some form of equity-based products, with variable annuities and segregated fund products most prevalent in the US and Canada, respectively. Companies are being challenged to generate the expected financial returns from their equity-based products, in light of the prolonged equity market downturn. Almost all (96%) respondents offering equity-based products have seen their earnings from these products impacted by the drop in the equity markets.

However, according to the survey, few life insurers appear to be proactively managing the risks associated with the equity-based product guarantees. Over half of these respondents rely solely on passive strategies such as collecting fees and paying claims, or holding additional capital, and another 38% use reinsurance to manage these risks. Only 16% are pursuing hedging strategies to manage the downside risks associated with the guarantees offered on these products.

“To date, many companies have attempted to manage the risks from guarantees using passive approaches, like collecting fees and holding additional capital. The prolonged market downturn has significantly increased the gap between the level of guarantees and the underlying fund values on these contracts, resulting in a significant increase in exposure and higher claims payments. This drain on earnings is forcing companies to take a closer look at their risks � increasingly, companies are looking to hedge their downside exposure,” according to Hubert Mueller, survey sponsor and Leader of Tillinghast’s Financial Management Practice for North America.

The negative impact from the prolonged market downturn has also forced many companies to unlock their Deferred Acquisition Cost (DAC) assets. Approximately 70% of companies already have written down or are considering unlocking their DAC assets, and many companies are considering a revision to their DAC amortization methodology, resulting in lower earnings.

The NAIC is currently considering an American Academy of Actuaries recommendation that Risk Based Capital standards for variable products with guarantees be based on company-specific stochastic modeling. This so-called “C-3 Phase II” proposal affects variable annuities with guaranteed minimum death, income and account benefits. The effective date is expected to be year-end 2003. While a majority of respondents are aware of the proposal, only 3% have conducted the relevant scenario testing; 23% have yet to address the requirements, but plan to do so; and 17% are taking a wait-and-see approach.

“As this proposed standard could have a significant impact on required capital, companies should start performing the stochastic testing now to analyze the expected impact rather than waiting for the requirement to be implemented next year,” said Alastair Longley-Cook, Senior Consultant with Tillinghast’s Financial Management Practice, during a recent conference call with the participating CFOs.

Optimism About Third-Quarter Results

Despite the recent economic turmoil and mixed results to date, respondents expect moderate growth in the third quarter.

Over 40% of respondents predict that third quarter revenues will grow greater than 10% over the same quarter last year. The CFOs are similarly optimistic about net income growth. More than a quarter (30%) of respondents expect a similar rate of growth in net income; however, 34% of respondents predict a decrease in net income, possibly due to asset defaults at the beginning of the quarter.

These results reflect CFOs’ outlook at the time they completed the survey and may or may not reflect company performance that actually emerges. CFOs’ views on future financial results for the industry will be a regular feature of the quarterly Tillinghast � Towers Perrin Life Insurance CFO survey and will allow Tillinghast to track the direction of the industry over time.

Respondents are fairly optimistic about the outlook for new life and annuity premium growth over the next three years, with almost half predicting increases of greater than 10% per annum.

About the Tillinghast � Towers Perrin North America Life Insurance CFO Survey

The Web-based survey, which was conducted in August of this year, is the second in a series of Tillinghast pulse surveys that explore issues important to the North American life insurance industry and its CFOs. The second survey had a respondent base of 30, or 47% of the program’s 64 survey registrants. Respondents primarily included CFOs from large and midsize North American life insurance companies: 65% were stock companies; 60% had premium income of more than $1 billion; 23% were multinationals. The third CFO survey, taking place in early November, will focus on the CFOs’ assessment of key industry challenges in 2003. For more information on the North American Life Insurance CFO program, please contact Michele Bacik, program leader, at 212-309-3921.

About Tillinghast � Towers Perrin

Tillinghast provides actuarial and management consulting to financial services companies and advises other organizations on their self-insurance programs. Tillinghast is a premier independent advisor to the insurance industry; its major clients include most of the world’s top insurance organizations. It operates as one global business, through a network of 43 offices in 20 countries. Tillinghast is a division of Towers Perrin, one of world’s largest management and human resource consulting firms. Towers Perrin provides global human resource consulting and administration services, helping organizations create people solutions that meet business and financial needs. More information about Tillinghast is available at