The Variable Annuity (VA) guarantee product is arguably the most complex equity–based guarantee available to individual investors. The intricacies of the GMxB (Guaranteed Minimum Benefits) rider stem from policyholder discretion in both the investment fund choice/allocation and the use of reset features. In addition, the longevity risk inherent in the embedded option makes hedging of the product as much an art as a science.

VA guarantee riders have many risk exposures–many of which cannot be fully quantified. Related to this, pricing and reserving for the VA guarantee risk have not always incorporated all of the risk drivers in estimating the financial performance of the product, partly due to existing software and hardware limitations. However, there are some risk exposures such as hedge cost, which are often thought of as quantifiable, but without considering that the calculated cost is only valid within the valuation framework (usually with assumptions related to efficient markets).

In light of this complexity, the hidden cost of VA guarantees could potentially expose the insurance industry to significant systemic risks. With this in mind, the CIA, CAS, and SOA's Joint Risk Management Research Team and Committee on Finance Research are interested in an exploration of the risks related to VA guarantees and how better informed judgments can be made on these products.

The CIA, CAS, and SOA's Joint Risk Management Research Team and Committee on Finance Research are seeking researchers to develop a quantification framework for better evaluation of the risks associated with VA guarantees. In formulating a framework, the organizers are interested in the following major topics and objectives. Given the broad scope of this RFP, respondents are free to submit proposals that only address certain aspects of the objectives listed below, rather than all objectives.

Systemic Risk

• Objective: Establish an estimate of the systemic exposure currently facing the North American insurance market by considering the following:

1. An extreme level of basis risk that results in hedge slippages;
2. An extreme level of illiquidity in derivative instruments that prevent efficient rebalancing in dynamic replication programs;
3. The impact of en masse perfect rational policyholder behavior;
4. Combined impact of all factors during an extreme market disruption similar to the depressed equity markets faced from September 2008 to March 2009;
5. An external event that causes the failure of a counterparty.

The quantification of systemic risk should be focused on identifying an event concurrent with discretionary fund management, hedge slippages and rational policyholder behavior that might lead to a failure of one or many VA writers currently operating in the market place. The research should further quantify the possible collateral damage to the entire financial market that might be caused by such high profile failures. What would be the impact if there was loss of a large insurance brand, due to loss of investor confidence and the loss of insurance coverage for a large sector of the population.

• Objective: Identify/create mitigation strategies that can generate more manageable risk profiles for the VA guarantee:

1. Explore mitigation strategies that reduce one or all of basis risk, hedge slippage and policyholder impacts;
2. Quantify the effectiveness of each strategy by reference to the exposure estimated for the Systemic Risk Factors (1–4) noted above. Thereby, quantify by using a relative value measure the mitigating impact of more prudent approaches. For this objective, assume that the current commonly used hedge strategies remain in place. But, if possible, other hedge strategy approaches can also be quantified in this context.

Risk Modeling and Industry Practice

• Objective: Investigate and recommend practical modeling techniques that can help VA writers (both large and small scale) to better quantify their exposures to systemic risks. This objective should focus on tools that can be implemented by most insurers, and that can provide for a practical, timely and regular assessment of the risk for a given block of business. This might include the following considerations:
1. More comprehensive or integrated ESGs that encompass several complex risk drivers such as the implied volatility surface, correlations between various markets, and/or liquidity factors–that better characterize extreme events;
2. Better attuned formulas and approaches to modeling policyholder behavior based on a scale of rationality–and that might be adjusted relative to the drivers within the ESG;
3. Approaches to quantifying the assessment of basis risk in the context of market dynamics;
4. Operational Risk.

In conclusion, this effort should focus on recommendations that practitioners can incorporate into their risk management and pricing of VA guarantees, and that can lead to better awareness of the systemic risk exposure potentially building up within this sector of the industry. It is the goal of this effort that this will lead to more informed decision-making on the part of all participants and stakeholders in the market place.

To facilitate the evaluation of proposals, the following information should be submitted:

1. Resumes of the authors, including any graduate student(s) expected to participate, indicating how their background, education, and experience bear on their qualifications to undertake the research. If more than one author is involved for each report, a single individual should be designated as the lead researcher and primary contact. The person submitting the proposal must be authorized to speak on behalf of all the authors as well as for the firm or institution on whose behalf the proposal is submitted.
2. An outline of the approach to be used. Details should be given regarding the manner in which appropriate published material will be identified and evaluated, search techniques to be used, collateral material to be consulted, and possible limitations of the review and analysis. Suggestions for survey revisions or expansions should be included.
3. Cost estimates for the research, including computer time, salaries, report preparation, research costs, etc. Such estimates can be in the form of hourly rates, but in such cases, time estimates should also be included. Any guarantees as to total cost should be given and will be considered in the evaluation of the proposal. While cost will be a factor in the evaluation of the proposal, it will not necessarily be the decisive factor.
4. A schedule for completion of the research, identifying key dates or time frames for research completion and report submission.
5. Other related factors that give evidence of a proposer's capabilities to perform in a superior fashion should be detailed.

The CIA, CAS, and SOA's Joint Risk Management Research Team and the SOA's Committee on Finance Research are responsible for the selection of the proposal to be funded. Input from other knowledgeable individuals may also be sought, but the CIA, CAS, and SOA's Joint Risk Management Research Team and Committee on Finance Research will make the final decision. The SOA's Research Actuary will provide staff actuarial support. A Project Oversight Group (POG) will be appointed to oversee the project upon selection of the proposal.

Any questions regarding this RFP should be directed by fax, or e–mail to:

Steven Siegel
SOA Research Actuary
ph: 847.706.3578,
f: 847.273.8578

If you intend to submit a proposal, please e–mail written notification by June 15, 2012  to:

Barbara Scott
Society of Actuaries
475 N. Martingale Road, Suite 600
Schaumburg, IL 60173–2226 or
ph: 847.706.3592
f: 847.273.3592

Please e–mail a copy of the proposal to: Barbara Scott at bscott@soa.org.

Proposals must be received no later than June 30, 2012. It is anticipated that all proposers will be informed of the status of their proposal by July 2012.

Note: Proposals are considered confidential and proprietary.

The Joint Risk Management Section and Committee on Finance Research reserve the right to not award a contract for this research. Reasons for not awarding a contract could include, but are not limited to, a lack of acceptable proposals or a finding that insufficient funds are available. The Joint Risk Management Section and Committee on Finance Research also reserve the right to redirect the project as is deemed advisable.

The Joint Risk Management Section and Committee on Finance Research intend to copyright and publish the results of this research. The research will be considered work–for–hire and all rights thereto belong to the Joint Risk Management Section and Committee on Finance Research. However, appropriate credit will be given to the researcher(s).