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The Younger Members Convention Fair value 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire
The Younger Members Convention
Fair value
2-3 December 2002
The De Vere Daresbury Park Hotel, Warrington, Cheshire
Agenda
• A brief update on International Accounting Standards (IAS)
• Key issues and questions• Examples
– Annuity– Unit-linked– With-profits
A brief update
Phase 1To be implemented by 2005Settles definition of insurance contractsAllows current local GAAP for contracts within
definition but with additional disclosureReview of existing standards (IAS 39) for
contracts outside definition
Phase 2Full IAS to be implemented by 2007
Summary of EU Position
Assets
IAS 39 applies
in all cases
Is it an insurance contract?
Liabilities
Local GAAP IAS 39 Insurance IAS
NoYes Pre 2007
Yes Post 2007
Agenda
• A brief update• Key issues and questions• Examples
– Annuity– Unit-linked– With-profits
What are the issues?
• Can we implement IAS?• Will our business even be classified as
insurance?• Will stochastic projections be required?• How do results compare with existing
methods?
Key questions and concerns
• What is the impact on day 1?• How volatile are profits likely to be?• Is the communication of results likely to cause
problems?• How will analysts interpret the results?• What will be the impact on our share price?
Agenda
• A brief update• Key issues and questions• Examples
– Annuity– Unit-linked– With-profits
Methodology & principles: A brief re-cap
• Asset/liability approach• Prospective discounted cash flow approach• Best estimate market consistent assumptions• Allowance for non-market risk• Entity specific value• Stochastic vs deterministic
Annuity
• Pension annuity• Single life, male age 75• Level annuity £2,500 p.a.• Tax rate 30%• Corporate bonds, duration matched• Corporate yield curve, 5.5% flat• Government yield curve, 5.0% flat
Non-linked annuity : Analysis of emergence of profit
-500
-
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
Time
Cum
ulat
ive
prof
it (£
)
Statutory Embedded value Fair value
Annuity - sensitivities
• 0.5% downward shift in yields• Yield curve steepening• 0.5% increase in credit spreads
Results - Annuity
Yield -0.5%
Statutory
Embedded value
Fair value
716
-28
-600
-400
-200
0
200
400
600
change in profit compared to base caseyield -0.5%
Results - Annuity
Yield rotation
Statutory
Embedded value
Fair value
472
00
-600
-400
-200
0
200
400
600
change in profit compared to base caseyield rotation
Results - Annuity
Statutory
Embedded value
Fair value
-446
-46
-446 -600
-400
-200
0
200
400
600
change in profit compared to base casecredit spread +0.5%
Annuity - Conclusions
• Day 1 fair value liability will be greater than embedded value liability
• Fair value profit sensitive to cash flow matching
• Fair value profit sensitive to change in credit spreads
• Different results obtained for different product classes (e.g. term assurance)
Agenda
• A brief update• Key issues and questions• Examples
– Annuity– Unit-linked– With-profits
Unit linked savings
• Unit-linked savings• Male age 40• Term 30 years• Annual management charge of 1% p.a. • Monthly premium £100• Initial fund size £5,000
Unit Linked : Analysis of emergence of profit
-
100
200
300
400
500
600
700
800
1 2 3 4 5 6 7 8 9
Time
Cum
ulat
ive
prof
it (£
)
Statutory / IAS 39 Embedded value Fair value
UL Savings - sensitivities
• Surrenders increased by 25%• Fall in equity values of 25%• Expenses increased by 50%
Results - UL Savings
Surrenders +25%
Equity -25%
Expenses +50%
Statutory
Embedded value
Fair value-140
-120
-100
-80
-60
-40
-20
0
20
Unit linked - Conclusions
• Day 1 fair value liability will be similar to embedded value liability
• Volatility of profits similar under fair value and embedded value
• …..unless smoothing currently applied in EV• Other issues
– Are these insurance contracts?– What allowance should be made for future renewals?
Agenda
• A brief update• Key issues and questions• Examples
– Annuity– Unit-linked– With-profits
Unitised with profit (UWP) bond
• Male age 55• Single premium £15,000• 1% annual management charge• Annual and terminal bonuses• Market value adjustments (MVA) apply• MVA free date on 10th anniversary
With profits - Key issues
• Prevalence of guarantees• Requirement to do stochastic runs• Need to model management discretion
UWP Bond - sensitivities
• A fall in equity values of 25%• An increase in implied volatility of 5%
UWP Bond - sensitivity results
Change in Profit - 25% market fall
-800
-700
-600
-500
-400
-300
-200
-100
0
FV - S/H
EV - S/H
FV - Estate
EV - Estate
UWP Bond - sensitivity results
Change in Profit - Increase in vols
-600
-500
-400
-300
-200
-100
0
FV - S/H
EV - S/H
FV - Estate
EV - Estate
UWP Bond - further sensitivities
• Dynamic reversionary bonus (RB) rule• Dynamic asset allocation• Reduced equity backing ratio (EBR)• Static surrender rates
UWP Bond - sensitivity results
Change in "Profit" - 25% equity fall
-1000
-800
-600
-400
-200
0
Base
Dynamic RB
Dynamic EBR
EBR 40%
Static surrs.
UWP - Conclusions
• Day 1 impact will depend upon cost of guarantees
• Future volatility will depend upon:– Matching of assets– Management discretion– Policyholders reasonable expectations
Wider implications
• Regulatory impact?• The death of embedded values?• Better understanding and quantification of
risks
Summary
• Day 1 impact will be significant but will vary from product to product
• Results/profit will be more volatile
Comments/questions …
The Younger Members Convention
Fair value
2-3 December 2002
The De Vere Daresbury Park Hotel, Warrington, Cheshire
