Canadian Institute of Actuaries L Institut canadien des actuaires

Canadian Institute of Actuaries L’Institut canadien des actuaires 2009 General Meeting ● Assemblée générale 2009 Ottawa, Ontario ● Ottawa (Ontario) Session/séance : PD-19 Impact of Recessions on LTD Experience Speaker(s)/conférencier(s) : Jeff Schuh, Peter Douglas, Ken Fraser

2009 General Meeting Assemblée générale 2009 Agenda • • Evolution of the U. S. recession Historical connections between recessions and Group LTD experience in the U. S. • Canadian LTD metrics vs. Economic indexes • Canadian LTD Profitability vs. Economic indexes

2009 General Meeting Assemblée générale 2009 PD-19 Impact of Recessions on LTD Experience Jeff Schuh, VP & Senior Actuary ING Reinsurance

2009 General Meeting Assemblée générale 2009 U. S. Economic Timeline Summer 2007 - “Beginning of the end” • Trouble brewing in the U. S. housing market (prices dropping, inventories climbing, foreclosures up) • • MBS quality drops 2 large Bear Stearns hedge funds go bankrupt ($1. 6 B) due to MBS exposure – despite AAA rating • First crack in the edifice • Cost of borrowing up, spreads increase

U. S. Economic Timeline 2009 General Meeting Assemblée générale 2009 March 10 -16, 2008: “A very bad week” Monday • • Rumors circulate that Bear Stearns is running out of cash Stock begins to nosedive (slowed only by Spitzer scandal!) Thursday • • • Bear Stearns suffers run on bank as clients pull money Needed emergency cash or file bankruptcy overnight, call to JP Morgan and NY Feds send over analysts to look at the books Friday • • JP and Feds discover enormity of problem: sub-prime exposure, credit default swaps, interconnectedness with other banks Feds propose a loan $30 B to JP Morgan to fund Bear Stearns purchase Saturday • JP offers Bear Stearns $8 -12/share ($170 in 2007, $30 previous Friday) Sunday • • JP revises bid and offers $4/share Treasury Secretary Henry Paulson worries about “moral hazard”, insists that JP lower offer to $2/share to penalize Bear Stearns Economy limps along until the fall…

2009 General Meeting Assemblée générale 2009 U. S. Economic Timeline Sept 9 -16 th, 2008: “The Week America’s Economy Almost Died” Tuesday – Lehman Brothers stock drops 45% in one day Wednesday – LB announces earnings early, to no avail Thursday – LB computerized trading system freezes when JPMorgan demands $5 B collateral on short notice Friday • • • Paulson insists there will be no bailout, citing “moral hazard” issues Geithner declares “somebody needs to buy them” BOA and Barclays interested – but BOA purchases ML instead, Barclays drops out Sunday – LB files bankruptcy Tuesday • • LB goes under Stock market nose dives Banks unwilling to lend money, credit markets freeze up AIG nationalized after stock drops 61% Wednesday – Goldman Sachs and Morgan Stanley now teetering

2009 General Meeting Assemblée générale 2009 U. S. Economic Timeline September 20 $700 B bailout proposed September 21 GS and MS turn themselves into bank holding companies (all five major investment banks are gone) September 25 Washington Mutual becomes largest bank failure ever October 3 Congress passes bailout bill allowing government authority to purchase toxic assets or capital injections

September & November, 2008 2009 General Meeting Assemblée générale 2009 • • • Lehman Bankruptcy Bank of America acquires Merrill Lynch Federal Reserve rescues AIG Bailout Plan passed Goldman and Morgan Stanley become banks Washington Mutual seized Wells Fargo acquires Wachovia Fannie Mae/Freddie Mac bailed out Car Makers (Detroit) seek bailout President Obama elected Speed of economic collapse was startling…

2009 General Meeting Assemblée générale 2009

2009 General Meeting Assemblée générale 2009

2009 General Meeting Assemblée générale 2009

2009 General Meeting Assemblée générale 2009

Recessions Are Not Equal Opportunity Events 2009 General Meeting Assemblée générale 2009 (snapshot from early 2009)

2009 General Meeting Assemblée générale 2009 What does this have to do with Group LTD? • • • Potential for higher incidence rates Potential for lower termination rates (longer durations) Effect will vary by diagnosis, industry, occupation, demographics Statements above are logical and plausible, but largely anecdotal. What proof do we have that this linkage exists?

U. S. Evidence of LTD/Economy Linkage 2009 General Meeting Assemblée générale 2009 Metrics • • • M&A Impact on Group LTD Incidence (2000) Unum 2004 Incidence Study 2008 SOA Termination Rate Study ING Survey on Economic Impact (2009) New Academic Papers Profits • • • 1990 LTD Industry Profits 2008 Industry LTD Claims Review Recent Results from Select Insurers (Unum, Standard, Met)

2009 General Meeting Assemblée générale 2009 Impact of M&A on Group LTD Study by one U. S. insurer found LTD incidence rates and loss ratios increased immediately after M&A activity* – – Incidence rates 10 -15% higher after M&A date Annual incurred claims per employee were 21% higher Were these from employees who were very likely to be laid off? Does this differ from current environment where employment is uncertain and workers may be afraid to go on disability? Will there be a disability “echo” during economic recovery as postponed claims are filed and new claims arise from overworked staff? *Source: ING Reinsurance Disability Forum, 2000, Vol. 7, No. 2

2009 General Meeting Assemblée générale 2009 Unum Incidence Study • • Presented at SOA 2004 Anaheim Health Spring Meeting Unum LTD incidence rates from 1989 -2003 mapped against U. S. recessions of 1990 and 2001 Discovered correlations between incidence rates and macro-economic indexes Startling conclusion: incidence rates continued to rise after the 1990 recession, and officially peaked 16 quarters after the recession officially ended

2009 General Meeting Assemblée générale 2009

2009 General Meeting Assemblée générale 2009

2009 General Meeting Assemblée générale 2009 Conclusions of Unum Study Implications are troubling given current economic indicators…

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2009 General Meeting Assemblée générale 2009 U. S. Consumer Confidence Index

Qualifications with Unum Study 2009 General Meeting Assemblée générale 2009 • • Actual values and claim rates not available Correlations vs. causation No linear relationships Mix of business: results not corroborated by other insurers, current Unum results not adversely affected by recession (significant move down-market and concentration in “recession resistant” industries) 2001 recession incomplete, inconclusive during study period Not all recessions have similar effects More to Group LTD profitability than incidence rates However, the study served important role by generating discussion and increasing awareness of LTD/Economy linkage

ING Reinsurance Industry Survey 2009 General Meeting Assemblée générale 2009 • “Impact of the U. S. Economy on the Disability Market” – 9/2009 • Incidence Rates: – – – • Majority of participants felt economy had minimal impact on incidence or that incidence had declined “Some industries with increasing incidence rates are offset by tendency of employees in other sectors to hang on to their employment or RTW more quickly in order to avoid losing job” “We have experienced more instances in which claims submitted were not eligible because their hours were reduced below plan” Recovery Rates: – – – 78% felt recession had not affected recovery rates, however… 56% felt recession has dampened employers’ willingness to support RTW “There is less willingness to hold jobs open or make accommodation to allow some to return to work”

New SOA LTD Study: 2009 General Meeting Assemblée générale 2009 Short Duration (<5 yrs) Termination Rates Speaker noted only modest drop in termination rates during 2001, offset by increase in mortality Source: “SOA Experience Table Update” – Edd Bailey, Eric Poirier (2009 JHA Dynamics of Disability)

New Academic Studies from the University of Southern Maine 2009 General Meeting Assemblée générale 2009 (Center for Business & Economic Research) • “Long-Term Disability Claims Rates and the Consumption-to -Wealth Ratio” published in the Journal of Risk and Insurance [March 1, 2009] – – – • Purpose: investigate relationship between Group LTD claim rates and the economic indicators. Explore the ability of the consumptionto-wealth ratio to predict LTD submitted claims rates. ” Option Theory utilized as LTD insurance treated as put option Conclusion: “When the consumption-to-wealth ratio is low, claims rates are high. We find that the connection is fairly strong and robust” Predicting SSDI submitted incidence using time series (ARIMA) models – – Preview given at SOA Annual Meeting (Oct. 28 -28, 2009) Relatively high predictive power

New Academic Studies from the University of Southern Maine 2009 General Meeting Assemblée générale 2009 (Center for Business & Economic Research) The catch… • Consumption-to-Wealth Study: – – – Examined only two industry sectors: manufacturing and wholesale/retail. Based on Unum-only data This is an academic paper - Dynamic Ordinary Least Squares Cointegrating Regressions: • ARIMA Model: – Time series models are a black box, do not provide insight into reasons for predictive ability.

2009 General Meeting Assemblée générale 2009 U. S. LTD Industry Profits vs. 1990 Recession - LTD experience does not track directly with recession. Lagged effect? - Poor experience generally attributed to white collar lay-offs, liberal plan designs (physicians/attorneys), rise of managed care, etc. Source: Jan. 2009 GUAA presentation (Rich Clement – Smith Group)

2009 General Meeting Assemblée générale 2009 Council for Disability Awareness: 2008 LTD Claims Review • • 15 participating companies, representing 75% of U. S. disability market. Government Plan – – • Applications for SSDI benefits “surged” during 2008 SSDI approval rates continue to decline Private Plans – – – LTD insurers report that over past several years, incidence and durations have been declining Almost without exception, participants report that the 2008 -2009 downturn has not affected disability claims as of the reporting date “The participating member companies generally expect to see some influence on claims from the current economic downturn, although none predict a severe impact. ”

2009 General Meeting Assemblée générale 2009 Stan. Corp shows no adverse link between economy and overall Group Benefit Ratio Source: 9/10/2009 KBW Insurance Conference

2009 General Meeting Assemblée générale 2009 Drill-down into LTD-only benefit ratio yields similar results Source: 9/10/2009 KBW Insurance Conference

2009 General Meeting Assemblée générale 2009 Stan. Corp’s Quarterly Group Benefit Ratios - through 3 Q 09 Source: Stan. Corp’s quarterly earnings calls

2009 General Meeting Assemblée générale 2009 • Bad News: Unum shows uptick in LTD incidence rate during 3 Q 09. STD deteriorated as well. • Good News: Average size of claim decreased, claim volatility coming from “non-economically sensitive sectors”. Source: 9/9/2009 Annual Investor Meeting

Source: 9/9/2009 Annual Investor Meeting 2009 General Meeting Assemblée générale 2009

Source: 9/9/2009 Annual Investor Meeting 2009 General Meeting Assemblée générale 2009

Source: 9/9/2009 Annual Investor Meeting 2009 General Meeting Assemblée générale 2009

Met. Life Underwriting Results 2009 General Meeting Assemblée générale 2009 • The group disability morbidity ratio (96. 4%) was above the target range for the first time this year. • “Disability claim incidence picked up in the third quarter after several quarters of stable experience, although there was a similar up-tick in the year-ago period. ” • “Recoveries, which have been lower than anticipated all year, remained below expectations. ” Source: Met. Life Q 3 2009 Earnings Call - October 30, 2009

Links 2009 General Meeting Assemblée générale 2009 2004 Unum SOA Presentation http: //www. soa. org/files/pdf/033_bk-anaheim 04. pdf 2008 SOA Table: http: //www. soa. org/research/group-disability/2008 -ltd-study. aspx CDA 2008 LTD Claims Review: http: //www. disabilitycanhappen. org/surveys/CDA_LTD_Claims_Survey_2008. asp University of Southern Maine – Center for Business & Econ Research http: //www. usm. maine. edu/~cber/ LTD & Consumption to Wealth Ratio http: //www 3. interscience. wiley. com/cgi-bin/fulltext/122192705/HTMLSTARTW? CRETRY=1&SRETRY=0

2009 General Meeting Assemblée générale 2009 PD-19 Impact of Recessions on LTD Experience Peter Douglas, Instructor Math & Stats University of Regina

2009 General Meeting Assemblée générale 2009 PD-19 LTD During A Recession • Statistical Analysis – – – Historical Background Data Sources Impact on Incidence Impact on Termination US, Canadian and UK data

2009 General Meeting Assemblée générale 2009 Data Studies All of this data free on the web! But ideally we need longer Canadian LTD history.

2009 General Meeting Assemblée générale 2009 Historical Unemployment

2009 General Meeting Assemblée générale 2009 Canadian Economic Indicators

CIA LTD Studies 2009 General Meeting Assemblée générale 2009 • • Short history with key gaps Termination Rates – – • 1988 -97 Study released 2009 New study 2004 -8 underway Incidence Rates – – No study to date Planned 2009 study on hold

2009 General Meeting Assemblée générale 2009 CIA Terminations A: E ratios generally improved over time Regardless of changes in unemployment!

2009 General Meeting Assemblée générale 2009 CIA Terminations Detailed Results • Correlation of A: E Ratio • • Improvement over time more important than job market More terminations in poor job market? – • More soft claims (year 1 results) Biggest impact in years 4 -10?

2009 General Meeting Assemblée générale 2009 CPP Disability Approvals

2009 General Meeting Assemblée générale 2009 CPP Disability Approvals

2009 General Meeting Assemblée générale 2009 CPP Approval Rates • Subjective – Politics – Policy changes – Current political pressure? • Clear spikes when unemployment is high • Expect an increase in CPP approval rates for 2009 -10

2009 General Meeting Assemblée générale 2009 WCB Statistics • Results by province 1996 -2007 – Some gaps – Key stats added in 2000 – Not always consistent between WCBs • Key Statistical Measures – Number of Loss Time Claims – Payroll – % LTCs receiving benefits after 2 years

2009 General Meeting Assemblée générale 2009 Past WCB Studies • Incidence Improves During a Recession – Fewer inexperienced workers – Less safe equipment mothballed – Hazardous industries worst hit by economy • Fear of job loss – may increase or decrease incidence claims • No clear impact re cost per claim

2009 General Meeting Assemblée générale 2009 WCB Incidence Rates ($M adjusted payroll) Incidence of time loss claims decreases over period Unemployment generally decreases, but no clear link

2009 General Meeting Assemblée générale 2009 WCB Incidence Rates (per 100 Lives) More useful measure but shorter history Again no clear link to unemployment

2009 General Meeting Assemblée générale 2009 WCB Continuance (after 2 Years) History is short and incomplete. Most provinces see increase in longer term claims over time. No clear link to unemployment.

2009 General Meeting Assemblée générale 2009 SOA 1995 LTD Study Slightly longer history over full cycle. More data and results shown by quarter. Terminations inversely correlated to unemployment.

2009 General Meeting Assemblée générale 2009 SOA 1995 LTD Study Same data shown as XY Scatter plot. Downward trend indicates A: E ratios↓ as Unemployment ↑

2009 General Meeting Assemblée générale 2009 SOA 1995 LTD Study Regression models can be fit to data, but why? Clearly results are driven by more than unemployment.

2009 General Meeting Assemblée générale 2009 SOA 2008 LTD Report Recovery rates improved with both job market and time. Not clear which is most important, implication for recession

2009 General Meeting Assemblée générale 2009 SOA 1990 -99 DI Study Incidence Rates Incidence rates improved with job market Not clear they will get worse with job market.

2009 General Meeting Assemblée générale 2009 SOA 1990 -99 DI Study Incidence Rates Same data as XY scatter plot. Study does not look at termination A: Es by year

2009 General Meeting Assemblée générale 2009 UK Experience • UK Group Income Protection LTD • Typically 13 or 26 week EP • CMR 20 – Termination Experience 1995 -8 – Includes results from 1974 -98 – Experience grouped into 4 year periods – UK economic trends differed from US and Canada over much of this period

2009 General Meeting Assemblée générale 2009 UK Group Experience • No pattern based on employment or over time! • A: E high in periods of high UE (91 -4) and low UE (75 -8) • A: E low in periods of high UE (83 -6) and low UE (95 -8) • Economic forecasts were grim in the early period covered

2009 General Meeting Assemblée générale 2009 What Does the Data Tell Us? .

2009 General Meeting Assemblée générale 2009 What Does the Data Tell Us? • Incidence rates – Improved with job market in past • Other factors at work? – May deteriorate with job market • Plausible causation (stress, anti-selection) • Supporting data hard to find • CPP disability approval rates – Strongly correlated with unemployment in past.

2009 General Meeting Assemblée générale 2009 What Does the Data Tell Us? • Termination rates ? !? ! – CIA LTD shows no clear link to unemployment • Increase in early months (soft claims)? – SOA study indicates experience worsens with job market – UK study inconclusive – WCB may not be applicable – Crash when things are really bleak . • (UK 80 s)

2009 General Meeting Assemblée générale 2009 Links • CIA LTD – http: //www. actuaries. ca/members/publications/pub_index_2009_e. cfm • SOA 95 LTD – http: //www. soa. org/research/group-disability/96 -group-ltd-study-tables. aspx • SOA DI – http: //www. soa. org/research/limited-disability/hlth-1990 -99 -individual-disability-experience-committee-report. aspx • AWCBC – http: //www. awcbc. org/en/financialdataandkeystatisticalmeasuresksm. asp • UK CMR – http: //www. actuaries. org. uk/knowledge/cmi_reports • . OECD – http: //stats. oecd. org/index. aspx

2009 General Meeting Assemblée générale 2009 PD-19 Impact of Recessions on LTD Experience Ken Fraser, President Fraser Group

Recession and LTD Results 2009 General Meeting Assemblée générale 2009 • Data Sources – Fraser Group • • • – Canadian Incidence and Continuance Study Quick Profitability Survey Sources of Profit Survey Statistics Canada • • Gross Domestic Product Unemployment Rate

Quick Profitability Survey • Survey of Group carriers Data from 1992 to 2008 • A simple question? 2009 General Meeting Assemblée générale 2009 • • Were your results satisfactory in LTD? – Yes/No • 2008 data from 17 companies, 91% market share

Sources of Profit Survey • Survey of Group carriers Data from 1996 to 2008 • Profit as Percent of Revenue 2009 General Meeting Assemblée générale 2009 • • 2008 data from 12 companies, 81% market share

2009 General Meeting Assemblée générale 2009 Canadian Incidence and Continuance Study • • Experience Study Data from 2000 to 2003 • Exposure and Claim data from employers < 1000 lives • 2003 data from 13 companies, 34% market share

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2009 General Meeting Assemblée générale 2009 Conclusion • No obvious relationship of LTD results to macro economic

2009 General Meeting Assemblée générale 2009 • But we all believe there is one. • Why can’t we see it?

Problem with Financials 2009 General Meeting Assemblée générale 2009 • Reported LTD Financial results are not tightly linked to economy. – – – Valuation models may distort the direction, magnitude and timing of economic impacts. Management actions (underwriting and claim management) may deflect economic effects. Structural changes in the Insurance Industry may hide the economic impact (e. g. consolidation, regulatory action)

Problem with Financials 2009 General Meeting Assemblée générale 2009 • Don’t forget the revenue side • • • Under pricing as layoffs increase average ages Collectability of premiums Anticipatory rate increases

Problem with Financials 2009 General Meeting Assemblée générale 2009 • Theoretically better to look at claim fundamentals rather than final financial results – – • Incidence Recovery Even so, management will employ best efforts to modify impact. – – – More selective underwriting Tighter adherence to contracts More investment in claim management

Problem with Macro Stats 2009 General Meeting Assemblée générale 2009 • • Both economic and industry statistics are averages of industry and regional sectors. For instance, – Downturn in high tech (1999)may have different LTD impact than downturn in manufacturing (2009)

Problem with our Models 2009 General Meeting Assemblée générale 2009 • • Relationships are probably not linear. There is probably more than one independent variable – • • E. g. industry specific economic activity, financial strength of plan sponsor, age and occupation of employee, diversification of local economy These variables may interact to amplify or nullify effect on LTD There may be threshold relationships – Little or no impact until a certain level is exceeded (e. g. unemployment)

In summary 2009 General Meeting Assemblée générale 2009 • • There is a great deal of anecdotal evidence linking economic downturns to adverse LTD results. However, historical data does not show a causal relationship between macro economic measures and LTD financial results.

2009 General Meeting Assemblée générale 2009 In summary • Further research is needed and should focus on • • • Claim fundamentals vs financial results Narrow industry or regional segments The effect of intervening variables

Sources – Canadian Incidence and Continuance Study 2009 General Meeting Assemblée générale 2009 • Fraser Group and Denis Garand & Associates – Quick Profitability Survey • Fraser Group – Sources of Profit Survey • Fraser Group – Statistics Canada. Labour Force Historical Review 2007 (Table Cd 1 T 46 an). Ottawa, • Statistics Canada, 2008 (Cat. No. 71 F 0004 XCB). – Real Gross Domestic Product (GDP) per capita, Canada, 1981 -2007 • HRSDC calculations based on 1) Statistics Canada. Gross Domestic Product (GDP), expenditure-based, provincial economic accounts, annual (CANSIM Table 384 -0002). Ottawa: Statistics Canada, 2008; and 2) Statistics Canada. Estimates of population

2009 General Meeting Assemblée générale 2009 Questions?