Product Guarantees: The Price of Doing Business for Insurers

Tillinghast � Towers Perrin Survey Indicates Life Insurance CFOs are Enhancing Guarantees to Remain Competitive

New York, N.Y., November 06, 2003 � Most life insurance company CFOs believe that “guarantees” are critical to the sale of products such as universal life and variable annuities, given the volatile capital markets of the past few years, according to a recent Tillinghast � Towers Perrin (Tillinghast) survey. Guarantees on variable annuity (VA) products are particularly important � at least 75% of respondents rated both guaranteed death and living benefits as extremely or very important to the sale of their products relative to other drivers, such as commission levels, brand and sales, marketing and operational support, and other product features.

The three-part survey � the sixth in a Tillinghast series polling life insurance CFOs � examined participants’ views on product guarantees, their use of reinsurance and other alternatives to manage the risks associated with product guarantees, as well as CFOs’ expectations for third-quarter 2003 performance.

“Insurers are in a tough spot � they are facing intense pressure to drive sales to meet their financial objectives, but also must manage the risks of offering attractive product guarantees,” says John Fenton of Tillinghast. “Despite the increased exposure, we expect innovative guarantees to be a distinguishing factor for sales success going forward.”

In order to make products more attractive and competitive, 84% of respondents identified “revising product design/guarantees” as a critical action over the next six to twelve months. More than half of them (53%) are considering pricing changes. However, respondents are being cautious � nearly one-third expect to limit sales in the near term.

“The specific drivers of limits on sales vary by company and product line, but generally involve one of two themes: capital constraints and concern about risk exposure,” notes Mr. Fenton. “Some carriers have been hit with the double whammy of lower capital levels driven by equity market downturns (although this reversed itself to some extent during 2003), as well as increased sales of capital intensive products, such as fixed annuities. Others are concerned about taking on too much exposure to the equity market and/or assets purchased in today’s relatively low interest rate environment. The latter could come back to haunt insurers if interest rates rise significantly in the future.”

The survey also found that many insurers have enhanced product guarantees over the past two years because of the volatile equity market and the decline in interest rates. In particular, while nearly two-thirds of respondents have enhanced VA living benefit guarantees during that time, nearly half of the respondents still believe their guarantees are weaker than those of their competitors.

“Introducing competitive VA living benefit guarantees like guaranteed minimum withdrawals, guaranteed minimum accumulation benefits and guaranteed minimum income benefits has led to significant sales increases for the larger players, and resulted in a drop in sales for most other companies unable to offer such competitive benefits. As a result, the market share for the top 10 VA companies has increased from 60% last year to 67% this year,” according to Hubert Mueller, Tillinghast survey sponsor.

Risk and Capital Management: Room for Improvement

A little over half of respondents expressed a high degree of overall comfort with the depth and quality of their risk assessment for product guarantees. Yet, most are looking for ways to improve their risk management practices � over 60% plan to adopt more extensive scenario testing over the next six to twelve months.

“We are seeing a strong push by many insurers toward more sophisticated financial modeling capabilities, such as enhanced stochastic models,” says Jack Gibson, Tillinghast’s North America Life Insurance and Financial Services Practice Leader. “This is being driven by senior management’s need to better frame strategic decisions with a clear and complete understanding of risk/return tradeoffs, as well as anticipated changes in regulatory requirements for reserves and capital.”

Reinsurance � used to address mortality risk, investment risk and to provide capital relief � has become a major issue as well. A majority (88%) of respondents are concerned about the cost of reinsurance and 53% worry about lack of capacity. As a result, more insurers are considering other alternatives to manage the risk, such as static and dynamic hedging, and other alternatives to provide capital relief, such as using offshore entities and securitization.

CFOs Were Fairly Optimistic About Third-Quarter 2003

Overall, respondents are significantly more positive about growth in premiums, revenues and net income for the third quarter than they have been in prior surveys. Roughly 30% of companies anticipate growth of more than 10% in new life and annuity premiums and revenues. Nearly half of the respondents expect third-quarter net income to increase by more than 10% compared with the same period last year.

“The recovery in the equity market, as well as the abatement in asset defaults this year, have helped life insurers achieve significant improvements in earnings and even bigger improvements in net income compared to last year,” according to Mr. Mueller. “However, the low interest rate environment and the resulting spread compression for fixed products remain a cause of concern for the CFOs.”

These results reflect the CFOs’ broad industry 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 Tillinghast North American Life Insurance CFO Survey for tracking the direction of the industry over time.

Tillinghast � Towers Perrin North American Life Insurance CFO Survey

The Web-based survey, which was conducted in September 2003, is the sixth in a series of Tillinghast pulse surveys that explore issues important to the North American life insurance industry and its CFOs. The survey had a respondent base of 26; 37% of the program’s approximately 70 registered program members. Since all survey questions were not applicable to all companies, the respondent base varied from question to question. Respondents primarily included CFOs from large and midsize North American life insurance companies; 59% had assets of $5 billion or more; and 23% were multinationals. 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 insurers. It operates as one global business, through a network of 42 offices in 20 countries. Tillinghast is a division of Towers Perrin, one of world’s largest management and human resource consulting firms. The Towers Perrin family of businesses also includes Towers Perrin Reinsurance, a leading global reinsurance intermediary. Together, these businesses have over 9,000 employees in 23 countries. More information about Tillinghast is available at