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

Asset Liability Management: Identifying and Managing Risk

Chad MyersVice President

Asset Liability Management

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

Approaches to Risk Management▲ Pricing

▲ Structure

▲ Reinsurance

▲ Diversification

▲ Hedging

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

JNL Max Plan Rate vs. Market Rates

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

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

(%pe

rcen

t)

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

(%pe

rcen

t)

Highest Competitor 9 Yr Treasury Max New Money Competitor Average

Fixed Annuity Interest Spread

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Jan-

96

Ma

r-9

6M

ay-

Jul-9

6S

ep-

Nov

-Ja

n-9

7M

ar-

97

Ma

y-Ju

l-97

Sep

-N

ov-

Jan-

98

Ma

r-9

8M

ay-

Jul-9

8S

ep-

Nov

-Ja

n-9

9M

ar-

99

Ma

y-Ju

l-99

Sep

-N

ov-

Jan-

00

Ma

r-0

0M

ay-

Jul-0

0S

ep-

Nov

-Ja

n-0

1M

ar-

01

Ma

y-Ju

l-01

Sep

-N

ov-

Jan-

02

Ma

r-0

2M

ay-

(Net Spread %)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

(Net Credited Rate %)

Normalized Net Investment Spread Normalized Credited Rate

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

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

Perspective II Optional Benefits Elected: Year-to-Date September 2002

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%

Benefit Initial Premium Percentage

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

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

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.

Statutory Reserves – Major Product Categories

JNL Risk Profile

▲ Three main product types– Fixed annuities / Institutional (spread-

based)– Variable annuities (fee-based)– Life insurance (hybrid of spread and

mortality)

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

Risk Inherent in Spread Lending Businesses

▲ Interest rate risk

▲ Spread risk

▲ Credit risk

▲ Liquidity risk

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

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

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

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

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

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

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

JNL Liquidity Analysis *

0.0x

0.3x

0.5x

0.8x

1.0x

1.3x

1.5x

1.8x

2.0x

2.3x

2.5x

Oct

-98

Nov

-98

Dec

-98

Jan-

99

Feb

-99

Mar

-99

Apr

-99

May

-99

Jun-

99

Jul-9

9

Aug

-99

Sep

-99

Oct

-99

Nov

-99

Dec

-99

Jan-

00

Feb

-00

Mar

-00

Apr

-00

May

-00

Jun-

00

Jul-0

0

Aug

-00

Sep

-00

Oct

-00

Nov

-00

Dec

-00

Jan-

01

Feb

-01

Mar

-01

Apr

-01

May

-01

Jun-

01

Jul-0

1

Aug

-01

Sep

-01

Oct

-01

Nov

-01

Dec

-01

Jan-

02

Feb

-02

Mar

-02

Apr

-02

May

-02

Jun-

02

Co

vera

ge

Ra

tio M

ulti

ple

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

$20,000

Exc

ess

Liqu

idity

($m

illio

ns)

Excess liquidity-30 day horizon Excess liquidity-1 year horizonCoverage ratio-30 day horizon Coverage ratio-1 year horizon

* Ratio of Available Assets to Potential Obligations

JNL Approach to Liquidity Risk

Variable Annuities

▲ Fee-based business▲ Main drivers of profitability are

determined at pricing▲ Earnings variability driven by:

– Equity returns– Guaranteed benefits– Expenses

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

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

PopDown3%

PopDown2%

PopDown1%

Level Pop Up1%

Pop Up2%

Pop Up3%

Pop Up4%

Pop Up5%

Pop Up6%

Pop Up7%

Unhedged Hedged

Hedge Analysis

Rate Scenario

Where Does JNL Stand?