Patent Application
20120101853
1. Field of Invention
The present disclosure generally relates to a method and system for providing secondary credit protection for life and annuity policies. The methods and systems give the policyholder the ability to hedge a potential default of payment of the original issuing life insurance or annuity provider at term.
2. Background
Recently in the United States, a distressed economic environment has been prevalent. The largest insurer, American International Group, Inc. (AIG) received bailout money from the U.S. government to meet increased collateral obligations. Such events underline the incapacity of holding companies to deal with the current challenging credit market environment independently. There is in fact no measure as of now to determine if AIG is financially sound nor is there any means to evaluate policyholders' risk and exposure to AIG. Moreover, many major life insurance companies appear on unsure financial footing with the threat of collapse. Although the policies could be transferred to another life insurance company, there is no guarantee for the policyholder that this might actually be the case, not mentioning the potential delays of payment if collapse and/or transfer does occur.
No instrument currently exists nor is traded on the market that measures policyholders' credit risk and exposure to life operating companies and holding companies failure to pay death benefits. Only derivative instruments that evaluate debt and equity holders' risk currently exist. No credit protection instrument exists that covers the joint event of paying upon death of policyholder and prior default of the related insurer, or in the case of an annuity, the joint event of annuity payout date and prior default of the annuity issuer.
There is no way for a policyholder to hedge the risk against policy issuers' default, which has risen multiple-fold for policyholders in the years 2008 and 2009. The credit risk of default of policy issuers can be gauged by calculating the implied 30 year credit default swap (CDS) premium on the life insurance company, which is usually a subsidiary of a holding company whose debt is traded on the market. By looking at the difference of leverage between the holding company and the life insurance company, the credit CDS premium of the life insurance company can be implied. For example, Prudential Life Insurance Company went from 72 bps at the end of 2007 to over 200 bps in 2009.
In addition to life insurance, there are many life contingent risks in deferred annuities such as fixed and variable annuities for which the present technology would be applicable. For example, many such annuities provide what are known as Guaranteed Minimum Death Benefits (“GMDB”), which are benefits at the death of the policyholder which are based upon a contract specification that can include increases based upon fixed interest rates, annual increases in market returns and the like. The GMDB would then amount to a considerable component of the annuity contract. Because the GMDB are all obligations of the life insurer's general account, the GMDB are backed only by the general financial strength of the life insurers and therefore present the same default risk bearing issues involved for life insurance.
In view of the above, a need is recognized for new methods and systems to provide life and annuity policyholders the ability to hedge issuing policy life insurance companies' credit risk. A need is also recognized for this hedge to be realizable at low cost, easy to administer, purchase and explainable to retail policyholders.
The present disclosure is directed to a subject technology including an insurance contract which provides secondary credit protection. The benefits can be targeted in various ways. In one embodiment, a separate guarantor model utilizes a third party insurance company, bank, investment bank, clearinghouse or the like in which policies may be contracted. In another embodiment, a guarantor underwrites a rider on the original policy which, for an additional premium, provides credit protection by a highly rated third party. In still another embodiment, the environment 10 includes a specifically designed CDS, over-the-counter (“OTC”) or exchange, which (i) pays out upon life insurance company default on policyholder (at that part of the capital structure) and (ii) pays out only upon the death of the holder in the case of life insurance or annuity pay date in the case of an annuity.
A benefit of the subject technology is for the policyholders to practically remove all credit risk from their life insurance or annuity policies at minimal costs. The subject technology can offer a term credit hedge as well that would be in effect for a limited period of time such as 10, 15, 20 or 30 years, to lower even further the cost to the policyholder. The calculation of the premium utilizes a shorter term and the relevant NLG Policy Premium for the term of the policy chosen. For example, the premium could be $805, $1,085, $1,425, $2,615 per $1 MM of 10 year, 15 year, 20 year and 30 year policies respectively. The contracts could be turned into permanent at term if the policyholder wants to make the contract permanent, the contract premium being re-priced at the time of being made permanent.
It should be appreciated that the subject technology can be implemented and utilized in numerous ways, including without limitation as a process, an apparatus, a system, a device, a method for applications now known and later developed or a computer readable medium. These and other unique features of the system disclosed herein will become more readily apparent from the following description and the accompanying drawings.
So that those having ordinary skill in the art to which the disclosed systems and methods appertains will more readily understand how to make and use the same, reference may be had to the following drawings.
The subject technology overcomes many of the prior art problems associated with secondary credit protection for life and annuity policies. The advantages, and other features of the systems and methods disclosed herein, will become more readily apparent to those having ordinary skill in the art from the following detailed description of certain preferred embodiments taken in conjunction with the drawings which set forth representative embodiments of the present invention and wherein like reference numerals identify similar structural elements.
Herein a computer or server is one or more digital data processing devices used in connection with various embodiments of the invention. Such a device generally can be a personal computer, computer workstation (e.g., Sun, HP), laptop computer, tablet computer, server computer, mainframe computer, handheld device (e.g., personal digital assistant, Pocket PC, cellular telephone, etc.), information appliance, printed circuit board with components or any other type of generic or special-purpose, processor-controlled device capable of receiving, processing, displaying, and/or transmitting digital data. A typical computer includes random access memory (RAM), mechanisms and structures for performing I/O operations, a storage medium such as a magnetic hard disk drive(s), and an operating system (e.g., software) for execution on the central processing unit. The computer also has input and output devices such as a keyboard and monitor, respectively.
A processor generally is logic circuitry that responds to and processes instructions that drive a computer and can include, without limitation, a central processing unit, an arithmetic logic unit, an application specific integrated circuit, a task engine, and/or any combinations, arrangements, or multiples thereof. Software or code generally refers to computer instructions which, when executed on one or more digital data processing devices, cause interactions with operating parameters, sequence data/parameters, database entries, network connection parameters/data, variables, constants, software libraries, and/or any other elements needed for the proper execution of the instructions, within an execution environment in memory of the digital data processing device(s).
A module is a functional aspect, which may include software and/or hardware. Typically, a module encompasses the necessary components to accomplish a task. It is envisioned that the same hardware could implement a plurality of modules and portions of such hardware being available as needed to accomplish the task. Those of ordinary skill will recognize that the software and various processes discussed herein are merely exemplary of the functionality performed by the disclosed technology and thus such processes and/or their equivalents may be implemented in commercial embodiments in various combinations without materially affecting the operation of the disclosed technology.
Referring now to the
The secondary credit protection system is user-interactive and self-contained so that users need not leave venture to another address within a distributed computing network 12 to access a various information. The following discussion describes the structure of such an environment 10 but further discussion of the application programs and modules that embody the methodology of the present invention is described elsewhere herein.
The environment 10 includes one or more servers 14 which communicate with and as part of the distributed computer network 12 via communication channels, whether wired or wireless, as is well known to those of ordinary skill in the pertinent art. In preferred embodiments, the distributed computer network 12 is a local area network or the Internet. For simplicity, one server 14 is shown. Server 14 can host multiple sites and houses multiple databases necessary for the proper operation of the secondary credit protection system in accordance with the subject technology.
The server 14 is any of a number of servers known to those skilled in the art that operably connect a plurality of computers or clients 16 to the distributed computer network 12. For simplicity, only one client 16 is illustrated. The clients 16 have displays and an input device(s) as would be appreciated by those of ordinary skill in the pertinent art. Clients 16 typically provide user access to the environment 10. The clients 16 can also utilize a removable computer readable medium such as a CD or DVD type of media that is inserted therein for reading and/or writing to the removable computer readable media. The servers 12 and clients 16 may actually be configured identically.
Distributed computer network 12 may include any number of network systems well known to those skilled in the art. For example, distributed computer network 12 may be a combination of local area networks (LAN), wide area networks (WAN), or, as is well known. For the Internet, the preferred method of accessing information is the World Wide Web because navigation is intuitive and does not require technical knowledge.
Referring now to
The flow chart herein illustrates the structure or the logic of examples of the present technology, possibly as embodied in computer program software for execution on a server, a computer, digital processor or microprocessor. Those skilled in the art will appreciate that the flow chart illustrates the structures of the computer program code elements, including logic circuits on an integrated circuit, that function according to the present technology. As such, the present technology may be practiced by a machine component that renders the program code elements in a form that instructs a digital processing apparatus (e.g., computer) to perform a sequence of function step(s) corresponding to those shown in the flow charts.
Referring now to
The process 300 estimates the CDS risk premium for the life insurance company from a holding company's corporate debt that is traded on a secondary market. In the following example, INSCO is short for life insurance company and HOLCO is short for the holding company. Referring also to
At step 302, the process 300 determines the trading price of a 27 year corporate bond for the HOLCO. For example as shown in
At step 306, assuming a recovery rate of 60% in case of a company default by INSCO, the process 300 determines the present value of the premium cash flows over 27 years, weighted by the implied probability of the company survival according to, for example CDS Premium/[1-Recovery Rate]. In this example, the weighted present value equals 20.4%.
At step 308, the process 300 extracts the amount of leverage of HOLCO to determine an overcollateralization ratio. The leverage can be determined from HOLCO's balance sheet as of the end of the year and adjusted for separate accounts. For example, the overcollateralization ratio may be total assets divided by total liabilities. Pulling the amounts from
At step 310, the process 300 uses a Black & Scholes (B&S) pricing model for American Put Option to determine the implied asset volatility σa, based on the following assumptions: i) the 27 year risk-free rate is 3.4%; ii) a 0% dividend yield; iii) a 27 year term; iv) a current price of US$100; v) a strike price of US$97; and a put price that is equal to the present value of premiums as calculated above, i.e., 20.4%. As shown in
At step 312, the process 300 determines an implied put price and 27 year CDS premium for INSCO. The process 300 uses the implied asset volatility (e.g., 30.3%) in the B&S model to find out the implied CDS Premium for INSCO by stripping out the liabilities of anything that is not insurance reserves related. The stripped out overcollateralization ratio for INSCO is then 445,011/370,329=100/83.2. By only changing the strike of the option in the B&S model, the process 300 determines an implied put price of 20.5, which equates to a 27 year CDS premium for INSCO of 2.03%, using the same PV methodology as above.
At step 314 of
Each state has guaranty funds to help pay the claims of a financially impaired insurance company, but the states only insure a small portion of policyholder risk. For example, the maximum death benefit with respect to any one life changes from one state to the other, and ranges from $250K in California to $500K in New York and New Jersey. The maximum liability for present value of an annuity contract ranges from $100K in most states to $500K in New York for instance.
Typically, the amounts available are not enough to cover most of the total coverage of a policyholder in the case where the insurer defaults. Moreover, state guaranty funds are not pre-funded, except in the state of NY, and still pose systemic risk. However, the state guarantees are preferably taken into account when pricing the invented hedging instrument for policyholders. Still referring to
Referring now to
In
Column (3) is the probability of death P in year T. The probability of dying P(1) in year 1 is equal to the hazard rate in year 1 from column (3). P(2) is equal to S(1) multiplied by the hazard rate in year 2 from column 3. Hence, P(N)=S(N−1) S(N) are calculated similarly.
Column (4) is the maximum death benefit DB from the policy.
Column (5) is the probability of the Life Insurance Company to survive PFS at year T. In first year, PFS(1), the probability of the company surviving year 1, is one minus the company hazard rate. As noted above, the hazard rate for process 300, assuming that the life insurance company's CDS premium is 130 bps, is 3.25% for a 60% recovery rate. The hazard rate is the probability of default in any single year. PFS(2) is equal to PFS(1) multiplied by one minus the hazard rate. Hence, PFS(N)=PFS(N−1) * [1−hazard rate].
Column (6) is the probability of the INSCO goes under PFG at year T. The PFG equals one minus the probability of the life insurance company to survive PFS at year T from column (5).
Column (7) is expected remaining policies or expected losses EL that have not lapsed at year T, assuming an annual lapsing rate of 3.00% for the example. Expected remaining policies EL at year 1 are equal to one minus the lapsing rate. At year 2, the percentage of remaining policies is equal to the percentage of remaining policies at year 1 multiplied by one minus the lapsing rate. Thus, EL(N)=EL(N−1) * [1−lapsing rate].
Column (8) is the expected loss claim amounts PNLG at year T under the credit hedge contract that policyholders would make to the credit protection writer upon default of the original life insurance company, adjusted for lapsing policies every year. Such expected claim amount PNLG is calculated as (a) the maximum claim amount DB, which is the death benefit in column (4) multiplied by one minus the life insurance company recovery rate (60%) minus the state guarantee funds ($500K in our example), multiplied by (b) the probability of death P in column (3), multiplied by (c) the probability of the Life Insurance Company to go under PFG in column (6), multiplied by (d) the expected remaining policies EL at year T in column (7). In short, PNLG=[DB * [1−INSCO recovery rate]−state guarantee funds]* [P * PFG * EL].
Column (9) is the NLG expected policy premium cash flows from one policyholder EPP, calculated as the probability of surviving S at year T in column (2) multiplied by the NLG Premium multiplied by the size of the policy in millions. In year 1, for example, the EPP would be equal to S(1)×$7,690×2 (for 2MM Policy Size). By discounting cash flows in column (8) at a discount rate of 7.0%, the process 300 determines the present value of CDS premiums paid by policyholder to hedge against such insurance provider's risk. In this example, the process 300 results in a fair NPV of $6,507. The fair NPV may be grossed up, such as by 150%, to find the NPV of CDS premiums (or “Credit Premium”) that is charged to the policyholder with respect to the subject technology, i.e. the life insurance company's credit hedge. In this example, the result is a $9,761 grossed-up NPV of CDS Premiums.
The process 300 calculates the annual credit premium, whose cash flows present value to the same amount. In order to do so, the process 300 discounts NLG expected premium cash flow for an individual in column (9). In the current example, the process finds a NPV of NLG Premiums expected to be paid by policyholder, which is $197,161. The process 300 then implies the ratio to NLG premium of the insurance as the gross up NPV of CDS premiums over NPV of NLG Premiums. In the current example, ratio to NLG premium is $9,761/$197,161=4.95%. The annual credit premium ACP is therefore in average 4.95% of policy premium level NLG through the life of the policyholder, i.e. 4.95% times $7,690 times 2, or a $761 annual credit premium ACP.
Column (10) is an expected pay-out cash flow PCDS from the investor to the writer of the protection against life insurance provider's default, calculated as the annual credit premium ACP ($761 in our example) multiplied by the probability of surviving S to year T calculated in column (2). In short, PCDS=ACP * S.
Column (11) is the expected cash flow from the credit protection writer's perspective EFC, calculated as the expected amount of credit premiums PCDS in column (10) multiplied by the percentage of remaining policyholders at year T, minus the expected amount of claims PNLG in year T of the remaining policyholders of column (8). In short, EFC=PCDS * (% of remaining policy holders)−PNLG.
Column (12) is the expected cash flow from one policyholder's perspective without the proposed hedge EFWOH, calculated as (a) the amount of death benefit DB in column (4) multiplied by the probability of death P in column (3) minus (b) the sum of (i) expected NLG Premium paid at year T in column (9) and (ii) the expected loss claim at year T, which is column (8) PNLG divided by column (7) EL, to adjust for policyholders' lapsing rate, which does not apply for one isolated policyholder. In short, EFWOH=DB * P−[NLG+PNLG/EL].
Column (13) is expected cash flow from the policyholder's perspective including proposed hedge EFWH, calculated as (a) the amount of death benefit DB in column (4) multiplied by the probability of death P in column (3) minus (b) the sum of expected NLG Premium paid by policyholder in column (9) and expected annual credit premium ACP at year T. In short, EFWH=DB * P−[NLG+ACP]
The process 300 can calculate the IRR of the credit protection writer from the column (11) EFC, and the policyholder without hedge and with hedge from column (12) and (13) respectively. Policyholders essentially hedge credit risk of the insuring company by giving an ACP of $761, which is 0.04% of the size of the original life insurance policy, to practically remove credit risk.
In view of the above, the subject technology includes an insurance contract which provides secondary credit protection. The benefits can be targeted in various ways. In one embodiment, a separate guarantor model utilizes a third party insurance company, bank, investment bank, clearinghouse or the like in which policies may be contracted. In another embodiment, a guarantor underwrites a rider on the original policy which, for an additional premium, provides credit protection by a highly rated third party. In still another embodiment, the environment 10 includes a specifically designed CDS, over-the-counter (“OTC”) or exchange, which (i) pays out upon life insurance company default on policyholder (at that part of the capital structure) and (ii) pays out only upon the death of the holder in the case of life insurance or annuity pay date in the case of an annuity.
A benefit of the subject technology is for the policyholders to practically remove all credit risk from their life insurance or annuity policies at minimal costs. The subject technology can offer a term credit hedge as well that would be in effect for a limited period of time such as 10, 15, 20 or 30 years, to lower even further the cost to the policyholder. The calculation of the premium would be similar to the one described previously, only with a shorter term and the relevant NLG Policy Premium for the term of the policy chosen. For example, the premium could be $805, $1,085, $1,425, $2,615 per $1MM of 10 year, 15 year, 20 year and 30 year policies respectively. The contracts could be turned into permanent at term if the policyholder wants to make the contract permanent, the contract premium being re-priced at the time of being made permanent.
In another embodiment, the subject technology provides servicing of policies. Still referring to
Referring again to
It will be appreciated by those of ordinary skill in the pertinent art that the functions of several elements may, in alternative embodiments, be carried out by fewer elements, or a single element. Similarly, in some embodiments, any functional element may perform fewer, or different, operations than those described with respect to the illustrated embodiment. Also, functional elements (e.g., modules, databases, interfaces, computers, servers and the like) shown as distinct for purposes of illustration may be incorporated within other functional elements in a particular implementation.
It should be appreciated that the subject technology can be implemented and utilized in numerous ways, including without limitation as a process, an apparatus, a system, a device, a server, a computer, a method for applications now known and later developed or a computer readable medium. These and other unique features of the systems and methods disclosed herein are readily apparent from the description above. While the invention has been described with respect to preferred embodiments, those skilled in the art will readily appreciate that various changes and/or modifications can be made to the invention without departing from the spirit or scope of the invention.
This application claims priority to U.S. Provisional Patent Application No. 61/349,412, filed May 28, 2010, which is incorporated herein by reference.
| Number | Date | Country | |
|---|---|---|---|
| 61349412 | May 2010 | US |
