Ameriprise 2007 Annual Report Download - page 52

50 Ameriprise Financial 2007 Annual Report
Variable Annuity Riders
The guaranteed benefits associated with our variable annuities are
guaranteed minimum withdrawal benefit (“GMWB”), guaranteed
minimum accumulation benefit (“GMAB”), guaranteed minimum
death benefit (“GMDB”) and guaranteed minimum income benefit
(“GMIB”) options. Each of the guaranteed benefits mentioned above
guarantees payouts to the annuity holder under certain specific condi-
tions regardless of the performance of the underlying investment assets.
The total value of all variable annuity contracts has grown from
$49.5 billion at December 31, 2006 to $57.2 billion at
December 31, 2007. These contract values include GMWB and
GMAB contracts which have grown from $7.2 billion and
$1.4 billion at December 31, 2006 to $13.1 billion and $2.3 billion
at December 31, 2007, respectively. At December 31, 2007, the
reserves for the GMWB and GMAB were a positive $136 million
and $33 million compared to reserves of negative $12 million and
$5 million at December 31, 2006, respectively. The large increases in
the reserves for the GMWB and GMAB reflect the effects of a
substantial increase in long term volatility on the mark-to-market
value of the guarantees. At December 31, 2007, the reserve for the
other variable annuity guaranteed benefits, GMDB and GMIB, was
$27 million compared to $31 million at December 31, 2006.
We manage the market risk on the guaranteed benefits by product
design and by the use of financial derivatives which hedge the GMWB
and GMAB. The design of the GMWB is an example of how we use
product design to manage risk. The GMWB provision requires that
policyholders invest their funds in one of five asset allocation models,
thus ensuring diversification across asset classes and underlying funds,
reducing the likelihood that payouts from the guaranteed benefits will
be required to compensate policyholders for investment losses.
As a means of economically hedging our obligations under GMWB
and GMAB provisions, we purchase equity put and call options,
enter into interest rate swaps and trade equity futures contracts. The
notional amounts and the fair value of assets (liabilities) of derivatives
hedging our GMWB and GMAB were as follows:
December 31,
2007 2006
Notional Fair Notional Fair
Amount Value Amount Value
(in millions)
Purchased options and
futures $6,318 $338 $1,410 $171
Interest rate swaps 202 2 359 (1)
Written S&P 500
futures(1) (202) — (111) —
(1) These Standard & Poor’s (“S&P”) 500 futures are cash settled daily and,
therefore, have no fair value.
Interest Rate Risk—Variable Annuity Riders
The GMAB and the non-life contingent benefits associated with the
GMWB provisions create embedded derivatives which are carried at
fair value separately from the underlying host variable annuity
contract. Changes in fair value of the GMWB and GMAB are
recorded through earnings with fair value calculated based on
projected, discounted cash flows over the life of the contract,
including projected, discounted benefits and fees. Increases in interest
rates reduce the fair value of the GMWB and GMAB liabilities.
At December 31, 2007, if interest rates had increased by, hypotheti-
cally, 100 basis points and remain at that level for 12 months, we
estimate that the fair values of our GMWB and GMAB liabilities
would decrease by $127 million and $23 million, respectively, with a
favorable impact to pretax income. The GMWB and GMAB interest
rate exposure is hedged with a portfolio of longer dated put and call
derivatives and interest rate swaps. We began utilizing the puts and
calls as a way to improve effectiveness and reduce hedging costs.
These derivatives are an alternative to the more customized equity
puts we previously used. At December 31, 2007, we had equity puts
and calls with notional amounts of $5.3 billion and $954 million
related to GMWB and GMAB, respectively. The interest rate swaps
had notional amounts of $193 million and $9 million related to
GMWB and GMAB, respectively. We have entered into interest rate
swaps according to risk exposures along maturities, thus creating both
fixed rate payor and variable rate payor terms. If interest rates were to
increase, we would have to pay more to the swap counterparty, and
the fair value of our equity puts would decrease, resulting in a
negative impact to our pretax income. For a hypothetical 100 basis
point increase in interest rates sustained for a 12 month period, we
estimate that the negative impact of the derivatives on pretax income
would be $114 million. Of the $114 million, $95 million is attribut-
able to our GMWB and $19 million is attributable to our GMAB.
The net impact on pretax income after hedging would be a favorable
$14 million, which consists of a $32 million and $4 million favorable
impact attributable to our GMWB and GMAB, respectively, and a
$22 million negative impact related to DAC amortization.
Equity Price Risk—Variable Annuity Riders
The variable annuity guaranteed benefits guarantee payouts to the
annuity holder under certain specific conditions regardless of the
performance of the investment assets. For this reason, when equity
markets decline, the returns from the separate account assets coupled
with guaranteed benefit fees from annuity holders may not be suffi-
cient to fund expected payouts. In that case, reserves must be
increased with a negative impact to earnings. If, hypothetically, equity
markets had declined by 10% at December 31, 2007 and remain at
that level for 12 months, we estimate the negative impact on pretax
income before hedging to be $23 million attributable to GMWB,
$13 million attributable to GMAB and $11 million attributable to
GMDB and GMIB.
The core derivative instruments with which we hedge the equity
price risk of our GMWB and GMAB are longer dated put and call
derivatives; these core instruments are supplemented with equity
futures. The put and call contracts had notional amounts of
$5.3 billion and $954 million at December 31, 2007 for GMWB
and GMAB, respectively. The equity futures had notional amounts of
$174 million and $69 million at December 31, 2007 for GMWB
and GMAB, respectively. If, hypothetically, equity markets had
declined by 10% at December 31, 2007 and remain at that level for
12 months we estimate a positive impact to pretax income of
$27 million and $13 million from the options and futures for
GMWB and GMAB, respectively. The net equity price exposure to
pretax income from all of our variable annuity guaranteed benefits
after hedging would be a negative $9 million, which includes a
$4 million favorable impact attributable to GMWB, an $11 million
negative impact attributable to GMDB and GMIB and a $2 million