How Emerging Accounting and Regulatory Developments Will Impact the Insurance Industry

1. How Emerging Accounting and Regulatory Developments Will Impact the Insurance Industry Actuaries’ Club of Boston - Annual Meeting Jeff Johnson – John Hancock Financial Services Dom Lebel – Towers Watson September 22, 2011

2. AGENDA Agenda • Introduction • Solvency II • Own Risk and Solvency Assessment • Principles Based Reserves • Future IFRS

3. Introduction 3

4. INTRODUCTION A global shift in regulatory requirements is prompting change in the U.S. • Broader financial sector regulation • International Monetary Fund  Financial Sector Assessment Program (FSAP) • U.S. Department of the Treasury  Financial Stability Oversight Council • Evolving insurance regulation • International Association of Insurance Supervisors  Insurance Core Principles • European Insurance and Occupational Pensions Authority  Solvency II The International Monetary Fund reviewed the U.S. system of financial regulation in 2010 as part of its Financial Sector Assessment Program and will perform a peer review in 2012

5. INTRODUCTION Solvency Modernization – FrameworkInternational Global alignment to implement international standards

6. INTRODUCTION The emerging importance of theInternational Association of Insurance Supervisors (IAIS) • IAIS is an association of insurance regulators, representing 190 countries around the globe, with two stated objectives • Promote effective and globally consistent supervision of the insurance industry • Contribute to global financial stability • IAIS publishes regulatory principles and standards, defining requirements for effective insurance supervision of the insurance industry • NAIC must demonstrate that it observes IAIS principles and standards under Financial Sector Assessment Program (FSAP) • FSAP created jointly by IMF and World Bank in 1999 in response to Asian financial crisis, applies to all financial services sectors • 2010 review indicated that NAIC generally observes 25 of 28 core principles, but recommended strengthening of group supervision, risk management and corporate governance • Also, greater need for PBA

7. Solvency II 7

8. High-level overview of Solvency II Risk-based regulatory framework for all insurers based in EU (may be extended to pension schemes at some point) Principles-based not rules-based Aims to harmonize standards across the EU Currently due to be implemented on January 1, 2013, but the timeline is a subject of debate SOLVENCY II

9. Solvency II framework SOLVENCY II SOLVENCY II Pillar 1 Quantitative requirements Pillar 2 Qualitative requirements Pillar 3Disclosure requirements • Assets and liabilities measured market-consistently • Eligibility and classification of own funds • Solvency Capital Requirement (SCR) • Minimum Capital Requirement (MCR) • Risk margin • Supervisors shall review system of governance, capital structure and capital needs, and take any actions required • Corporate governance and effective risk management • Own risk and solvency assessment (ORSA) • Public disclosure in form of Solvency and Financial Condition Report (SFCR) • Disclosure to supervisors in Report to Supervisors (RTS) • Information includes details of business and performance, system of governance, risk exposures, concentrations, mitigation and sensitivities • Quantitative reporting templates Integrated risk and capital management framework

10. SOLVENCY II The Solvency II Balance Sheet Excess Assets Own funds Required capital SCR MCR Risk Margin Market Value of Assets Technical provisions Best Estimate Liabilities

11. Solvency II – SCR and MCR Technical Provisions (TP) – amounts set aside in order for an insurer to fulfil its obligations towards policyholders and other beneficiaries; market consistent valuation Solvency Capital Requirement(SCR) – level of capital that enables an institution to absorb significant unforeseen losses and gives reasonable assurance to policyholders and beneficiaries; 99.5% VaR over 1-year Minimum Capital Requirement(MCR) – a safety net that reflects a level of capital below which ultimate supervisory action would be triggered; 85% VaR over 1 year SOLVENCY II Internal model Level of SCR Standard approach Level of MCR Risk margin Ladder of Intervention Best estimate liability

12. SOLVENCY II Different methods to calculate the SCR • Solvency II provides a range of methods to calculate the SCR, which allows undertakings to choose a method that is proportionate to the nature, scale and complexity of the risks that they face

13. SOLVENCY II The EU has established a program to harmonize Solvency II with other regulatory schemes via Equivalence and Transition • European subsidiaries of a U.S. parent: • Will need to calculate local Solvency II capital requirement using the Solvency II methodology regardless of the final decision on equivalency • If the U.S. is not granted equivalence, then the European supervisor could require the U.S. group to set up a European insurance holding company • European parent company with U.S. subsidiaries • If the U.S. is granted equivalence, capital for U.S. subsidiaries will be based on (lower) NAIC RBC capital requirements in group Solvency II calculations • If the U.S. is not granted equivalence, Solvency II rules will need to be applied on a consolidated basis (i.e., including their U.S. business) • The first three countries to undergo equivalence assessments under the Solvency II regime are Bermuda, Switzerland and Japan • Rather than undertake a full assessment of the U.S., the European Commission has instead proposed a transitional regime • Countries eligible for this regime would be deemed equivalent for 5 years • It seems clear that the U.S. will be included in this transitional regime

14. SOLVENCY II Potential implications of Solvency II for U.S. companies • U.S. subsidiaries of European multinationals are currently undertaking multimillion dollar projects to prepare for Solvency II • If the U.S. is not deemed equivalent and current standards are ultimately implemented • Capital increases for U.S. subsidiaries of European multinationals for certain products (e.g., spread based products such as payout annuities) • Competitive benefit for U.S. domestic companies • Decreased credit ratings for U.S. subsidiaries of European multinationals • Withdrawal of U.S. subsidiaries of European multinationals from these product lines • U.S. subsidiaries of European multinationals enjoy better risk management framework • Better link between risk identification, risk appetite, risk management and economic capital • More timely risk information • Improved risk culture • U.S. parent companies of European subsidiaries set up European holding companies • U.S. regulatory and rating agency changes

15. ORSA 15

16. The IAIS and Solvency II both require an ORSA as part of solvency regulation; the NAIC and others are following suit ORSA 16

17. ORSA Overview of current (8/5/11) ORSA guidance manual draft • ORSA shall be completed at least annually • Regulator may or may not request the confidential filing each year • Some insurers/groups may be exempt • Individual insurers with gross premium less than $500M • Groups with gross premium less than $1B • Insurer’s/Group’s ORSA should contain three major sections: • Section 1 – Description of the Risk Management Policy • Section 2 – Quantitative Measurements of Risk Exposure in Normal and Stressed Environments • Section 3 – Group Economic Capital and Prospective Solvency Assessment

18. ORSA February March June July The NAIC has been developing a Guidance Manual for regulators to use in the implementation of ORSA 11 2/11 – 3/18 18 7 21 25 • NAIC issues “U.S. Own Risk and Solvency Assessment (ORSA) Proposal” • Comment period ends • NAIC issues initial guidance draft, “NAIC Own Risk and Solvency Assessment (ORSA) Guidance Manual” • Comment period • NAIC hosts “2011 ERM Symposium”: CRO Council members present on ERM • NAIC releases revised guidance manual draft

19. ORSA The Manual will be refined over the next couple of months and will be ready for use at the end of the year August October November 5 28 – 31 • NAIC target date to finalize guidance manual draft to send to industry for comments • GSIWG National Meeting (to review newly revised draft of ORSA proposal) • GSIWG Public Hearing on ORSA (final edits before adoption) • SMI Task Force • Receive and discuss proposal The NAIC has not announced an exact date for ORSA implementation  the NAIC feels pressure to meet 2012 FSAP requirements but companies are pushing for a longer timeline

20. PBR 20

21. PBR U.S. NAIC Principle-Based Reserves • Why PBR • 150 years of prescription • Change, complexity and capability • What is PBR • Reserves calculated using deterministic and stochastic (stochastic interest and equity) modeling • Many assumptions are based on company experience when credible, but some assumptions are prescribed • Reserves set at a conservative level consistent with statutory reporting • Reserve greater of NPR, DR and SR • Evolution of PBR • Asset adequacy analysis/cash flow testing (1989 in New York, 1992 and later for other states) • Can only increase formula reserves • Actuarial Guideline 35 – Reserves for equity-indexed annuities (1998) • Actuarial Guideline 43 – Reserves for variable annuities (2009) • VASFRI to address • Disincentives to hedge risks • Domination of the standard scenario • Volatility of results • Pro-cyclicality of capital requirements • Unpredictable results • Tax reserve issues

22. PBR U.S. NAIC Principle-Based Reserves • Where is PBR Today • NAIC adopted SVL to permit PBR November 2009 • Life Product Methodology being tested (VM-20 Impact Study) • NAIC Earliest completion date March 2012 • 2014? 2015? (US State approval and US Treasury Guidance) • Valuation Manual 20 – Reserves for life insurance • Valuation Manual 22 – Reserves for fixed annuities • Will only apply to business issued after the effective date

23. VM-20 participation summary and product coverage PBR • We recently received a significant amount of resubmissions to the Phase I submissions • All values in this presentation include the resubmitted results • Indexed Universal Life products are not included in this impact study due to lack of participation • Six participants have not submitted Phase I results yet, but expect to submit by mid September • In general, Phase I results often took participants much longer to submit than initially planned • Phase II results are coming in much quicker than Phase I results • At least a couple reinsurers had issues with resources, delaying obtaining mirror reinsurance reserves

24. Not all companies provided all aspects of VM-20 PBR • Usable products submitted is less than initial number of products planned for study due to: • A few products lost due to dropouts • A few products yet to be submitted • Average number of model segments per product is sometimes greater than one because some Term participants also provided results for ROP Term • As you can see, not all participants provided all reserves or exclusion tests

25. Summary impact of VM-20 on 1 year of business – Product “Per $1,000’s” are averages across participants, weighted by each participant’s amount PBR

26. Comments on the summary impact of VM-20 to today’s reserve levels For Term, in most cases the reserves decrease, but because of one large term participant that gave us results in the aggregate, we get conflicting results for Aggregate Term Were it not for this participant, Aggregate Term reserves would have decreased by 26% under Alt 1 and 31% under Alt 2 for 1 year of direct business, and decreased by 52% under Alt 1 and 53% under Alt 2 for 5 years of direct business, which is more in line with the other Term results For ULSG we see reserves increasing under VM-20 1 year of ULSG increased 51% and 25% under Alt 1 on a direct and net basis, respectively 5 year of ULSG increased 22% and 7% under Alt 1 on a direct and net basis, respectively The increase is less pronounced under Alt 2 and reserve even decrease 8% for five years of ULSG business under Alt 2 on a net basis It is notable that statutory reserves increase, but tax reserves decrease Whole Life reserves didn’t change because the DRET and SRET are always passed so the VM-20 reserve equals NPR which is defined to be CRVM for Whole Life For VUL, there is not much change in the aggregate But one VUL participant shows a slight increase, one show VM-20 reserves at zero, and the others show no change SIWL reserves increase, which is counterintuitive and being investigated This is due to one SIWL participant showing significantly increasing reserves while the others show no change PBR

27. VM-20 Observations We are awaiting the results of Phase II, follow up questions and a survey, but so far we can say: With help, companies have been able to work their way through VM-20 and calculate a number However, this required hundreds of questions and much clarification Plus, results took longer than expected Often due to constraints on resources, but not always The mortality process, NPR issues and starting asset iterations also played a role Results are sometimes counterintuitive and unexpected ULSG results are generally higher than CRVM/AG-38 There are some outliers in the SRET More data and analysis is needed to answer these questions Certain results may be due to specific product features and specifications Results often vary by significantly by product, and sometimes even within products Aggregation results in lower VM-20 reserves for Term participants (by 25%, but only a small sample) The number of scenarios ran by participant varied widely PBR

28. VM-20 Other Concerns Mature block impact Reinsurance Initial scope of VM Consistency with international standards PBR

29. Future IFRS 29

30. FUTURE IFRS Residualmargin Risk adjustment Discountedfuturecash flows Measurement of long-term insurance contracts Compositemargin • The discounted future cash flows represent a market-consistent value of the obligations arising from the contract • Include time value of money • Reflect all possible scenarios • Use current estimates • Reflect options and guarantees Eliminates any gain at inception (cannot be negative) Estimate of the effects of uncertainty about the amount and timing of cash flows Discountedfuturecash flows Estimate of future cash flows, adjusted for the time value of money IASB FASB A hybrid approach has been proposed that includes both economic as well as deferral and matching elements 30

31. FUTURE IFRS Presentation  Statement of comprehensive income Illustrative and simplified Other standards Financial instruments standard Insurance contracts standard

32. FUTURE IFRS Several key issues still unclear • Unbundling • Current proposal to unbundle embedded derivatives and certain explicit account balances • Guidance based on revenue recognition standard • Presentation • ED proposed a “release of margins” presentation • Significant pushback from industry has led to redeliberation • Transition • ED proposed a simplified method for transition that would not require significant margins for IF business • Significant negative feedback has led to redeliberation

33. FUTURE IFRS Timeline • Revised Exposure Draft/Review Draft – Q2 2012 • Likely to be much more limited in scope for soliciting comments • Further timing now uncertain • Final standard now unlikely before end of 2012 • Effective date uncertain – will not be before YE 2015

34. FUTURE IFRS Implications • Responding to exposure drafts and quantifying financial impact of changes • Practical Implementation Concerns • Significant increase in actuarial input necessary • Derivation of numbers might require new systems (software and/or hardware) • Reengineering of reporting function including increased controls • Communication of results • Results will behave differently than before • Likely to be increased volatility due to current nature of framework • Increased focus on explanation of results • May require reconciliation to other reporting frameworks • Interpretation/Usability • “Rules of thumb” may no longer be applicable • Likely need for different analytics • Might other metrics be necessary? • New business strategy and product design/pricing • Management of potentially unprofitable lines of business under the new accounting framework • Managing the potentially increased earnings volatility, for example, via improved asset/liability management and/or hedging

35. Contacts • Jeffrey L. Johnson, FSA, MAAA John Hancock Financial Services AVP and Actuary – Actuarial Policy US Finance jeff_johnson@jhancock.com • Dominique LeBel, FSA, FCIA, MAAA Towers Watson Director and Leader, Hartford Life Practice dominique.lebel@towerswatson.com