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Crunching the Numbers

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Annuity sales now comprise about half of all revenue for the life/health industry, and well above that of either life or health insurance. What do you think this says about the changing nature of this industry in general?

I think what it really speaks to is the changing nature of marketplace needs. It’s not so much about industry activity and things that the industry is doing in and of itself, but rather what the marketplace requires. Given demographic trends prevalent in the nation and given the status of government support of retirement income, the changing shape of corporate support of retirement income, the need for individuals to drive their own agenda as it relates to retirement is growing. And that combined with those demographic issues makes retirement income the primary financial need of American households. People are more concerned with outliving their money than dying too soon.

What is the real state of the annuity industry’s long-term financial sustainability? Can it sustain its current sales level given the guaranteed returns the industry is offering? Can it generate the capital it needs to make sure it meets its obligations?

I think you’re already seeing that kind of adjustment process since the financial crisis. I am very much of the view that the industry is able to adjust its offerings to respond to the marketplace needs we just spoke of but also to the risk management needs that are driven by capital market and volatility requirements. Since 2008, we have seen the industry adjusting to that through adjustments to level of benefits offered to the investor, and the price of those benefits. But I think it is much more interesting for us that we’ve seen something more fundamental go on as well, which is looking to take financial risk management and embody it in product design itself.

Companies have always engaged in responsible risk management in terms of managing their own balance sheets; that’s been the case for decades. In more recent years, companies have managed capital markets risk through their hedging programs. But this last point of evolution that I’m speaking to, of risk management embedded in product design, is the most recent frontier. And it is one in which we have been a leader and where we have seen a lot of the industry following suit, starting in 2011 and into 2012. The way a lot of companies are entering this space is somewhat different than ours but nonetheless the basic principle of account value protection that is built into the product design now is a big part of the industry responding to those things you mentioned. It has been a main driver of our success over the past few years.

People like variable annuities with ratcheting benefits because it insulates them from downside risk. Yet, the insurers who must pay for these have no such protection. How much of a concern is that, really?

In terms of industry sales, they’ve progressed since 2008, but compared to levels prior to that, they have been fairly stable. It’s not as if industry sales have gone on some enormous spike from the levels we observed four or five years ago.

Second, as sales have grown over the past few years, it has been against a backdrop of benefits being stepped down and prices stepped up across the industry. I think that indicates the right kind of responsible adjustments to capital markets volatility.

Third, your question is a very sound one. That’s why I think the industry is starting to make some of the adjustments that we made the cornerstone of our franchise several years ago, which is finding ways to protect client account values in highly adverse market situations and limit downside risk.

That is very attractive to us for risk management purposes, but also in terms of driving sustainable and profitable growth. Fundamentally, this type of design aligns the interests of the investors who buy our product and the Prudential shareholder who underwrites the promises embedded that product. Both parties benefit from the protection of account values in highly adverse markets.

There has been significant attention to contingent deferred annuities in recent months, and whether they are annuities or insurance. Why has Prudential argued so strongly that these products are annuities, and what are the risks to insurers who  sell them?

Our position on this is that when you look fundamentally at what CDAs do, they are the same thing as a variable annuity with guaranteed living benefits. We are insuring a lifetime income stream in a CDA design. That is what VAs with living benefits do. They guarantee lifetime income streams. That is the fundamental characteristic. They are primarily designed to address longevity risk. We see them as the same type of value proposition with the same type of inherent risks. We think that our approach to risk management that we have used in the VA space is very much the foundation of how we intend to manage risk in the CDA space. And we think it is just as applicable in that space as in the variable annuity space.

The risk nature of the assets that would underly a CDA are not tremendously different from the assets that are embedded in a VA, especially our VAs, and we think that the agreements that will enter into regarding diversification and required allocation of assets will make the risk characteristics highly manageable and similar to what they are in our VA business.

We found the whole nature of the process with the NAIC Subcommittee and with the Committee to be highly constructive, very candid and informative with lots of transparency and an open dialogue all around. Just what we’ve come to expect with good relations with the regulators, but certainly manifested yet again in this area.

The reason we’re interested in CDAs is, despite growth in VAs, VAs still represent a very small slice of the financial services landscape and small slice of household financial assets. We think CDAs are very important because they allow the guarantee of lifetime income to pertain to a much broader pool of potential assets, and therefore a broader pool of potential clients. For example, the clients who invest their assets on separate platforms. CDAs provide an opportunity for those clients and their financial advisors to continue to work together to generate and to satisfy long-term investment objectives, and for a portion of those assets to underpin lifetime income guarantees.

As insurers become increasingly focused on retirement products, and as products become more investment-oriented rather than insurance-oriented, is there a chance that the industry is innovating faster than it can handle and straying from core competencies that it spent many years perfecting?

Innovation has become very often a $10 word for layering on risk. And that’s not how we see innovation at all. We see in our case, our success as having taken place not despite commitment to rigorous risk management but precisely because of our commitment to it. We’ve developed a way to manage risk that aligns interests of both investors and our shareholders by protecting account values that also protecting interests of Prudential shareholders.

That innovation is not at all layering of risk, but the highly effective management of risk in a value proposition that is compelling in marketplace but is also sustainable from a risk management and a shareholder perspective.

And we think CDAs, done properly with same dedication to innovation, and innovation in area of risk management can afford additional opportunities.


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