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Adam Schenck. (Photo: Allison Bell/ALM)

Life Health > Annuities > Variable Annuities

Annuity Hedging Is Working Well: Milliman's Adam Schenck

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When your clients are trying to manage personal financial risk, they call you, and you might help them buy annuities, or cash-value life insurance.

When the issuers worry about what the S&P 500 is doing, some of them call Adam Schenck.

Schenck is happy to take the issuers’ calls.

“As a citizen, I worry about financial markets and inflation, but our strategies have done well lately,” Schenck said.

Schenck is a managing director at Milliman’s 24-year-old, Chicago-based Milliman Financial Risk Management unit, and head of that unit’s fund services arm. He said Milliman and the investors that fund the hedging vehicles it uses have plenty of capacity to help clients manage more risk.

He believes that smart use of hedging can maximize your clients’ retirement income.

“We’re obviously in a different world, but people still need to invest in equities,” Schenck said.

Hedging increases life insurers’ and clients ability to stick with equities, he added.

What It Means

In bull markets, you might think mainly about which stocks the sun is shining on.

In bear markets, you and your clients might think harder about the risk-management umbrellas.

Adam Schenck

Milliman is a Seattle-based firm that’s best known for its actuarial consulting work. Through actuarial consulting, it helps insurers do the math that makes insurance work.

Schenck’s team does something else: It helps life insurers and other institutional clients set up exchange-traded options contracts, over-the-counter custom derivatives and other hedging arrangements with companies that pump capital through the Chicago Mercantile Exchange, the Chicago Board of Trade, and other exchanges and OTC markets all around the world.

The hedging arrangements the Milliman’s team oversees, from offices in London and Sydney as well as Chicago, are protecting about $185 billion in assets.

Schenck has a bachelor’s degree in computer science and math from Eckerd College and a master’s degree in financial math from the University of Chicago. He holds the Chartered Financial Analyst professional designation.

He came aboard at Milliman in 2005, just after the 2000-2002 “dot-com bubble” tech stock price meltdown, and as a few analysts were worrying about the residential mortgage lending bubble that would soon bring about the 2007-2009 Great Recession.

Milliman Financial Risk Management

Many life insurers of all sizes have their own, in-house hedging teams. Other insurers work with outside investment firms that rely mainly on customized, over-the-counter derivatives to manage risk.

Milliman focuses mainly on providing risk management services for insurers that want to outsource part or all of their risk management operations.

Milliman can and does set up custom derivatives arrangements, but, when possible, it uses off-the-shelf exchange-traded options contracts, to hold down costs and maximize the transparency and liquidity of the hedging arrangement, Schenck said.

For a life insurer or other institutional investor, one advantage of working with Milliman is that Milliman charges a flat, asset-based fee, rather than fees based on revenue and performance, he said.

Schenck’s Perspective

In an interview, Schenck said shared his perspective about how the world of institutional financial risk management works.

1. The 2000-2002 “dot-com bubble” popping helped educate life and annuity issuers about the idea of hedging variable annuity risk.

Before the tech stock bubble popped, many life insurers used traditional portfolio risk-management strategies, and “a lot of them weren’t hedging,” Schenck said.

After the bubble popped, life insurers began to use derivatives to hedge much more of the investment market risk they assumed.

Now, Schenck said, regulators look skeptically at issuers of market-linked products that are not using derivatives-based hedging strategies.

2. The 2007-2009 Great Recession gave life and annuity hedging another boost.

Since then, “the investment set has evolved,” Schenck said. “The investment has gotten more liquid. Especially options.”

3. In the institutional options and derivatives markets Schenck uses, liquidity is great.

Strategists in some financial market sectors have reported seeing poor liquidity, meaning that sellers have a hard time completing mutually acceptable transactions with buyers.

Liquidity has not been an issue in Schenck’s world.

“There are a lot of players,” he said. “A lot of market makers.”

Even when the number of players looks small, letting everyone know an interesting deal is available brings out more players, he said.

4. The term “derivatives breakage” is misleading.

Life insurance company executives sometimes talk about the level of “breakage” in their hedging arrangements.

The executives are almost never talking about any problems with derivatives counterparty defaults, Schenck said.

Instead, he said, life insurers are talking about the performance of derivatives used to hedge risks that are not a great fit for those derivatives.

When life insurers say breakage is increasing, “it just means the derivatives didn’t track the movement in the underlying value perfectly,” Schenck said.

5. Providers of bare ETFs can have annuity-like risk management features, too.

Innovator Capital Management, a money manager, now uses a Milliman-designed program to buffer ETF investors against investment losses — outside of an annuity or life insurance package.

Innovator does that by using the same kind of options program that an indexed annuity issuer might use, Schenck said.

By using a risk-managed fund outside of an annuity contract, an investor may lose annuity-related tax advantages but gain trading flexibility, Schenck said.

Pictured: Adam Schenck. (Photo: Allison Bell/ALM)