08 Dec 2005 1

Accountant PerspectiveAccountant PerspectiveOn Appraisal

Value DerivationOn Appraisal

Value DerivationConference: Dynamic Solvency Testing & Appraisal Value

Thursday, 8 December 2005

Ballroom Sahid Hotel Jaya – Jakarta

Presented by : Simon Imanto – Head Finance and Accounting

PT AIG Life

08 Dec 2005 2

• How to Measure a Life Insurance Company

• Different Measures of the Same

• Statutory Profits– Key Drivers

• Achieved Profits– Profit Factors

– Key Drivers

– Reporting

– Areas for Focus

Topics

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Some methods are used by:

Info Bank Magazine

Investor Magazine

Bisnis Indonesia Newspaper

How to Measure a Life Insurer

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Info Bank Magazine

1. Risk based capital (RBC)

2. Liquidity

3. Statutory deposit / reserve

4. Investment / reserve + claim payable

5. Fixed asset / equity

6. Gross premium growth

7. Net premium income / equity

8. Net investment income / average of investment

9. Expense (claim + expense + commission)/net premium income

10. Profit (loss) before tax / average of equity

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Investor Magazine

1. Asset growth 4 years

2. Shareholders’ equity growth 4 years

3. Technical reserves growth 4 years

4. Net premium income growth 4 years

5. Investment return growths 4 years

6. Total revenue growths 4 years

7. Net profit growths 4 years

8. Underwriting profit growths 4 years

9. Return on assets (ROA)

10. Return on equity (ROE)

11. Risk based capital (RBC)

12. Total asset turn over (TATO)

13. Market share based on net premium

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Bisnis Indonesia Newspaper

1. Risk based capital (RBC)

2. Liquidity

3. Productive asset ratio

4. Solvency

5. Investment return

6. Return on equity

7. Cash flow

8. Economic scale

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Statutory ReportsPUBLISHED FINANCIAL STATEMENT YEAR 2004 (in the newspapers)

A B C D E FINVESTMENTTotal Investment 4,760,322 3,541,061 3,097,049 2,672,067 2,568,145 2,437,858 NON INVESTMENTTotal Non Investment 481,360 300,630 318,963 123,141 111,720 135,688 Total Assets 5,241,682 3,841,691 3,416,012 2,795,208 2,679,865 2,573,546

PAYABLETotal Payable 614,001 197,121 76,868 179,404 14,715 329,598 TECHNICAL RESERVETotal Technical Reserve 3,653,301 3,283,004 2,941,200 2,249,662 923,186 1,924,371 Total Liabilities 4,267,302 3,480,125 3,018,069 2,429,066 937,901 2,253,969 Subordinate Loan - - - - - - EQUITYPaid in Capital 477,711 4,500 235,000 111,500 1,497,813 4,500 Stock Agio 22,289 12 3,038 10,000 104,646 - Reserve (Advance of Paid in Capital) 2,836 5,046 114,102 - (702,620) - Increase (Decrease) Marketable Securities 107,612 974 - 30,606 - 51,700 Fixed Assets Valuation Difference - 7,862 - - 593 - Unrealised Profit of Stock (138,692) - - - 161,768 - Retained Earning 502,624 343,172 45,805 214,036 679,764 263,377 Total Equity 974,380 361,566 397,944 366,142 1,741,964 319,577 Total Liabilities and Equity 5,241,682 3,841,691 3,416,012 2,795,208 2,679,865 2,573,546

Balance Sheets

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Statutory Reports – cont.1

A B C D E FIncomePremium Income 2,051,576 1,045,684 1,527,648 1,561,393 774,243 1,077,840 Reinsurance Premium (24,894) (14,544) (8,676) (18,649) (10,411) (12,028) Decrease (Increase) UP (2,502) 152,353 (2,921) 95 235 2,664 Total Net Premium Income 2,024,180 1,183,493 1,516,051 1,542,839 764,067 1,068,476

Investment Income 518,264 351,660 283,470 428,801 443,071 207,859 Other Management Fee 5,342 15,403 1,275 - - 7,842 Other Income 5,215 116,722 14,204 7,591 1,658 57,912 Total Income 2,553,001 1,667,278 1,815,000 1,979,231 1,208,796 1,342,089

ExpensesTotal Claim and Benefit 1,838,517 970,152 1,404,624 1,333,817 827,015 1,067,784

Amortization of Deferred Acquisition Cost 201,515 219,810 62,993 333,121 28,607 111,800 Marketing 3,139 5,045 74,437 59,592 3,147 6,420 General and Administration 178,312 168,508 206,612 89,166 26,660 75,008 Other Income (Expense) 122,907 (25,407) 19,942 546 - Total Expenses 2,344,390 1,338,108 1,768,608 1,816,242 885,429 1,261,012

Profit (Loss) Before Tax 208,611 329,170 46,393 162,989 323,367 80,967 Income Tax (15,256) (38,623) (588) (970) 23,738 (68) Profit After Tax 193,355 290,547 45,805 162,019 347,105 80,899

Profit & Loss Statements

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Different bases but what’s the difference?

• Local Statutory

• Income Less Expenditure

• Cash

• US GAAP

• Modified Statutory Basis (MSB : UK GAAP)

• Achieved Profits

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ONLY TIMING DIFFERENCES

• Statutory Profits is a one year snapshot

• Achieved Profits takes into account the income and expenditure arising over the entire life that the policy is in-force

The difference is ….

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Statutory Profit - Key Drivers

Sales Volumes (growth rates, new business strain) Product Mix (reserving basis, new business strain) Distribution Cost Persistency (renewal premiums) Expenses Claims Investment Performance

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Only one year profit - does not reflect total value to company of business written

New business strain leads to loss

Not a reflection of underlying profitability

Problems with Statutory Profit

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Achieved ProfitsAchieved Profits

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Achieved Profit New Business Achieved Profit - accounts for all expected

future profits in the year that business is sold, on a discounted basis

In Force Achieved Profit – expected IFAP is the increase in the value of profits over the year as the discounting period reduces

Experience variances are differences between expected achieved profits during the year and actual achieved profits

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Achieved Profit

Reflects value to company of business written

No new business strain

Cost of capital allowed for

Experience variances show where better or worse performance than assumed

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Achieved Profits - Achieved or Achievable??

Achieved Profits is based on assumptions of future events: Investment returns Persistency Claims Expenses Tax

Then discounted to a Net Present Value using a selected Risk Discount Rate

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Achieved Profits - Key Drivers

New Business Achieved Profits (NBAP): Sales Volume Profit Factor:

Product type & emergence of statutory profits Assumptions (economic & non-economic) Risk Discount Rate

In-force Achieved Profits (IFAP) Risk Discount Rate Actual experience of:

Expenses Persistency Claims

Assumption changes

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Achieved ProfitsAchieved Profits = Change in Embedded Value + current year Statutory Profit

Embedded Value = Net Present Value of future expected Statutory Profits

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Achieved Profits - Key Reporting Measures

Weighted New Business Sales (“APE” or “FYP”)

[Regular + 10% Single Premium]

NBAP

[NBAP from regular & single]

AP Margin % = ___NBAP__

APE or FYP

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Achieved ProfitsNEW BUSINESS ACHIEVED PROFITS A Headline figure

IN-FORCE ACHIEVED PROFITS:

Unwind of discount rate on b/fwd smoothed EV B

Achieved Profit Experience Variances

Expenses C1 Indicator of how close to reality Persistency C2 are the assumptions Claims C3

Total experience variances C = C1+C2+C3

Shareholder fund D

Change of assumptions E

Total In-Force Achieved Profits F = B+C+D+E

OPERATING ACHIEVED PROFITS G = A + F

Investment Related Variances H

TOTAL ACHIEVED PROFITS BEFORE TAX I = G + H

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Achieved Profits An Example

Achieved Profits FY 2005FY 2005

Rp'millionNew Business Achieved Profits (Reg + Single) A 35,000.0

In-Force Achieved ProfitsUnwind of discount rate on b/fwd smoothed EV B1 11,000.0

Achieved Profit Experience Variances Expenses B2a (17,500.0) Persistency B2b 3,000.0 Claims B2c 2,000.0 Others (please specify) - Future losses on NB B2d - Total experience variances B2 (12,500.0)

Shareholder fund B3 -

Change of assumptions(please explain in commentary) B4 -

Total In-Force Achieved Profits B (1,500.0)

Total Operating Achieved profits C=A+B 33,500.0 1)

Investment Related Variances D 12,500.0 2)

Total Achieved Profit Before Tax E=C+D 46,000.0

Tax F -

Total Achieved Profit after tax G=E+F 46,000.0

08 Dec 2005 22

Achieved Profits - An Example Full Year 2005 - Achieved Profits

Total Value of Shareholders' Fund

Stat BasisEmbedded

ValueTotal Fund on an achieved basis

Rp'million Rp'million Rp'million

Accumulated Achieved Profits B'fwd at 31/12/2004

Embedded value 120,000.0 120,000.0 Share capital 100,000.0 100,000.0 Share premium 10,000.0 10,000.0 Profit & Loss account (40,000.0) (40,000.0) Total 70,000.0 120,000.0 190,000.0

Full Year 2005 Movements Prior year adjustments Profit & Loss account -

New Share Capital 20,000.0 20,000.0 Change of ownership Statutory Profit 15,000.0 15,000.0

Operating Achieved profits 33,500.0 33,500.0 1) Investment related experience variances 12,500.0 12,500.0 2)

Achieved profits on ordinary activities before tax (including actual investment gains) 46,000.0 46,000.0

Tax Tax on statutory basis - - - Tax on achieved profits - -

Dividend - - FX Movement Accumulated Achieved Profits C'fwd as at 31/12/2005 105,000.0 166,000.0 271,000.0

08 Dec 2005 23

Asset ValuationAsset Valuation

08 Dec 2005 24

MOF Decree 424/KMK.06/2003

Summary of financial soundness – see attached

Considered Points for revising :

• Gov. Bonds : based on book value

• Statutory Deposits : could be allowed investing on Gov. Bonds

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Deferred TaxDeferred Tax

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Deferred Tax

Identify timing/temporary difference between fiscal & Accounting

Differentiation Balance Sheet according to Fiscal & Accounting:

• Fixed Assets• Bad Debt Expenses• Accrual Expenses – Expense incurred but non-deduct able

cost according to fiscal

To be recounted BV per accounting records vs fiscal• If the fiscal BV > accounting BV = Deferred Tax Liability• If the fiscal BV < accounting BV = Deferred Tax Assets

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Deferred Tax – cont.1

Temporary Difference:• A different between the tax basis of an asset or liability

and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled, respectively

Timing Difference:• Differences between the periods in which transactions

affect taxable income and the periods in which they enter into the determination of pretax income

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Type of Temporary Differences

• Revenues or gains that are taxable after they are recognized in financial income (e.g., percentage of completion for financial purposes and completed contract for tax purposes, or use of the full accrual method for financial purposes and the installment method for tax purposes)

• Expenses or losses that are deductible after they are recognized in financial income (e.g., accrual of product warranty expense for financial purposes but deducting when paid for tax purposes)

• Revenues or gains that are taxable before they are recognized in financial income (e.g., including the entire amount of advance rental payments in taxable income but deferring and recognizing when earned for financial purposes)

08 Dec 2005 29

Type of Temporary Differences (2)

• Expenses or losses that are deductible before they are recognized in financial income (e.g., depreciating an asset under the accelerated depreciation method for tax purposes but under straight-line for financial purposes)

• An increase in the tax bases of assets because of indexing for inflation

• Business combinations accounted for by the purchase method (i.e., the differences between the assigned values and the tax bases of the assets and liabilities recognized)

08 Dec 2005 30

Deferred Tax – an example

2004 2005 2006 2007Pre-tax accounting income 100,000 100,000 100,000 100,000 Temporary differences:- Depreciation (15,000) (5,000) 5,000 15,000 Taxable income 85,000 95,000 105,000 115,000

Tax rate 30% 30% 30% 30%Income tax expense 25,500 28,500 31,500 34,500

Depreciation methodTax 40,000 30,000 20,000 10,000 Accounting 25,000 25,000 25,000 25,000 Temporary difference 15,000 5,000 (5,000) (15,000)

Cummulative Temp. Diff 15,000 20,000 15,000 - Tax rate 30% 30% 30%Deferred Tax Liability 4,500 6,000 4,500

08 Dec 2005 31

Deferred Tax – an example (2)

2004 2005 2006 2007Pre-tax income 100,000 100,000 100,000 100,000

Income tax expense- Current 25,500 28,500 31,500 34,500 - Deferred 4,500 1,500 (1,500) (4,500) Total income tax expense 30,000 30,000 30,000 30,000

Net income 70,000 70,000 70,000 70,000

Journal entries2004 Dr. Income tax expense - deferred 4,500

Cr. Deferred tax liability 4,500

2005 Dr. Income tax expense - deferred 1,500 Cr. Deferred tax liability 1,500

2006 Dr. Deferred tax liability 1,500 Cr. Income tax expense - deferred 1,500

2007 Dr. Deferred tax liability 4,500 Cr. Income tax expense - deferred 4,500

08 Dec 2005 32

Valuation of Tax Losses

Valuation of Tax Losses

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An Examples: Tax Loss Utilization

Rp. Million 2001 2002 2003 2004 2005 2006 2007 2008

Result - Profit before Tax (5,000.0) (7,500.0) (2,500.0) 2,000.0 1,500.0 (6,000.0) 3,000.0 5,000.0

B/F losses 0.0 (5,000.0) (12,500.0) (15,000.0) (13,000.0) (11,500.0) (17,500.0) (13,000.0)new (losses) (7,500.0) (2,500.0) 0.0 0.0 (6,000.0) 0.0 0.0Loss utilisation: by year of loss

2001 5,000.0 2,000.0 1,500.0 1,500.02002 7,500.0 3,000.0 4,500.02003 2,500.0 2,500.02004 0.02005 0.02006 6,000.0 2,500.02007 0.0

Loss C/F (12,500.0) (15,000.0) (13,000.0) (11,500.0) (17,500.0) (13,000.0) (3,500.0)

08 Dec 2005 34

An Examples: Tax Loss Utilization (2)

Year Tax loss Year Wasted Year Used-1 Year Used-2

2001 5,000.0 2007 1,500.0 2004 2,000.0 2005 1,500.0 2002 7,500.0 2008 4,500.0 2007 3,000.0 - - 2003 2,500.0 2009 - 2008 2,500.0 - - 2004 - 2010 - - - - - 2005 - 2011 - - - - - 2006 6,000.0 2012 N/A 2008 2,500.0 - - 2007 - 2013 - - - - -

Total 16,000.0 6,000.0 10,000.0 -

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Accountant Perspective On Appraisal Value Derivation

Thank You