1 / 34

European Embedded Value, first year application

European Embedded Value, first year application. Alberto Minali March 10th, 2005. Introduction. Group. A newly established set of principles for EV calculations provides a better valuation of all risk components, in particular of embedded options

gryta
Download Presentation

European Embedded Value, first year application

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. European Embedded Value, first year application Alberto Minali March 10th, 2005

  2. Introduction Group A newly established set of principles for EV calculations provides a better valuation of all risk components, in particular of embedded options Ras is one of the first international companies and the first Italian company to publish EEV in compliance with CFO forum principles Values and methodology have been certified by Tillinghast-Towers Perrin The 2003 discount rate has been recalculated for comparative purposes only; 2003 results have not been restated 1

  3. Agenda Italy Methodology and main results Portfolios characteristics Cost of options Financial risk margin Non-Financial Risk Margin Conclusions 2

  4. The alternatives Practice widely used by competitors, with risks partially captured in the discount rate and partially in projected inflows. Overlapping of stochastic and deterministic frameworks Discount rate not diversified by product, highly subjective (top-down risk premium) and based on market information (beta) Top-down discount rate based on WACC or CAPM methodology, with one single risk premium and cost of options deducted from total In-force value Discount rate tailored to the specific risk factors of different products and different companies, with bottom-up valuation of risk premiums. Important impact on risk management Consistent link between stochastic and deterministic frameworks Bottom-up discount rate based on valuation of risk factors, with differentiated risk premiums by Line of business and country Ras choice 3

  5. Further details on methodology Group • Risk premium is obtained as the sum of different risk components on top of the risk-free rate. Ras has identified and measured the following ones: • Margin for embedded options: the time value of the put option cost sold to policyholders (calculated in a stochastic environment) is expressed as basis points of risk premium • Margin for financial risk: neutralises the equity component assumed in projected investment returns. Linked to equity exposure and equity risk premium • Non-financial risks: associated with lapses, mortality, longevity and business risks, calculated using the Ras Risk Capital Model The risk premium obtained is company-specific, business-specific, valuation-dependent. Ras calculates a different discount rate for Traditional Life, unit linked and Asset management business in Italy 4

  6. Traditional products discount rate Italy Risk free equivalent to 10 year bond yield - data in % Remarks Decrease of overall discount rate arises from the risk free rate reduction of 75 bp Stable financial risk margin is consistent with unchanged equity exposure and risk premium Strong increase in time value component of put options is due to the term structure shift Higher non-financial risk premium driven by an increase of lapses risk 6.61 -31 6.30 Non-financial risks 1.15 +26 1.41 Financial Risk margin 0.89 0.79 -10 Time Value of options 0.15 0.35 +20 Risk free 4.50 -75 3.75 Change in bp 2003 2004 5

  7. Unit Linked discount rate Italy Risk free equivalent to 10 year bond yield - data in % Remarks 75 bp decrease in risk free rate is partially compensated by the increase of other risk factors Higher financial risk margin is linked to the higher average equity exposure Higher non-financial risk premium driven by lapses risk 6.75 6.55 Non-financial risks -20 1.78 2.03 +25 0.47 Financial Risk margin 0.77 +30 Risk free 4.50 -75 3.75 Change in bp 2003 2004 6

  8. Asset Management discount rate Italy Risk free equivalent to 10 year bond yield - data in % Remarks 75 bp decrease in risk free rate is partially compensated by the increase in other risk factors Higher financial risk margin is linked to the higher average portfolio duration and equity risk premium Higher non-financial risk premium driven by volumes and higher capital absorption 7.30 7.00 Non-financial risks -30 1.45 1.65 +20 1.35 Financial Risk margin 1.60 +25 Risk free 4.50 -75 3.75 Change in bp 2003 2004 7

  9. Preliminary conclusion Group 2003 old 2003 new 2004 new • The new methodology enables: • to measure the immediate impact of different ALM strategies on the risk profile of our business and therefore on the EV • to assess the impact of different technical product features (e.g., redemption or penalty fees) on the discount rate and therefore on pricing Traditional 2.50% 2.11% 2.55% Unit Linked 2.50% 2.25% 2.80% Asset Mgmt 2.50% 2.80% 3.25% With this new methodology in place Ras can now enhance both risk and value mgmt 8

  10. Agenda Italy Methodology and main results Portfolios characteristics Cost of options Financial risk margin Non-Financial Risk Margin Conclusions 9

  11. Ras portfolios Group Traditional products: the tight Asset-Liability strategy reflects Ras long-term expertise in AL techniques, with very limited A-L cash flow mismatch and low equity exposure Unit-linked: very conservative equity exposure of high volatility periods; in 2004 Ras took advantage of better financial market conditions to slightly increase investment risk profile Asset Management: a good balance of equity and bond exposure, almost unchanged during 2004, due to the still cautious approach of clients to financial mkts 10

  12. Traditional portfolio Italy Ras Vitariv - starting year 2005 - equity exposure 6%, corporate bond 19.2%, 2004 recorded return 5.02% of which 4.96% ordinary Projected financial returns and avg. min. guaranteed Asset and Liability cash flow Yield 1,250 990 5.0% 750 500 Assets 3.4% 4.7% -600 -800 -850 -700 Liability years 2005 2015 2.9% Cash flow Mismatch years 2015 2005 +400 +190 +150 -200 11

  13. Unit linked and Asset Management Italy Asset Management Unit Linked Equity 24% 26% 43% 43% 7% Balanced funds 76% 7% 74% 50% 50% Bond and liquidity 2003 2004 2003 2004 12

  14. Agenda Italy Methodology and main results Portfolios characteristics Cost of options Financial risk margin Non-Financial Risk Margin Conclusions 13

  15. Further details on methodology Group The stochastic model projects portfolio financial returns in a neutral risk probability environment The model is calibrated on the interest rate structure at valuation date and on implied market volatility Projected financial returns consider: existing assets; management options to steer financial returns; accounting rules Cost of options is very limited due to tight ALM and conservative equity exposure Financial returns are still higher than minimum guaranteed rates Cost of options increased in 2004 due to lower interest rates; this offsets the positive effect of new products with non-cliquet options 14

  16. 36.3 16.8 16.8 5.4 Time Value component of cost of option Italy Total Italian portfolio Total Cost of time value Total group in Italy Ras-Vitariv Absolute value mln euro Non-financial risks Time Value of options 0.15 0.35 Financial Risk margin In % of traditional Reserves 0.29 0.27 Risk free 0.16 0.11 2003 2004 2003 2004 2003 2004 Ras Vitariv 0.37 0.17 15

  17. Projected Financial scenarios and returns Financial returns of segregated funds generated by stochastic model Financial returns of segregated funds are determined considering the accounting rules and management rule Accounting rules: financial returns credited to policyholders are not marked to market but based on accruals + dividends + realised capital gains Management rule: the possibility for management to steer financial returns and to reduce their volatility Scenarios Financial returns Best estimate years 16

  18. Price of the put option The stochastic model runs 5,000 scenarios and therefore 5,000 financial returns are generated For each financial return below the minimum guaranteed rate, the model calculates losses incurred by the shareholder The net present value of these losses, weighted for the probability of the individual scenario, determines the cost of the put option The put option has two components. Intrinsic value and Time value Scenarios Financial returns Minimum guarateed rate layers years Cost of option NPV weighted for probability years 17

  19. Put option breakdown in intrinsic and time value 2004 data Scenarios Financial returns Minimum guarateed rate Best estimate years years years Time value Put value Intrinsic value 36.3 - Mln euro = 107.3 71.0 16.8 Ras Vitariv 47.0 30.2 Already captured into the deterministic EV 18

  20. Financial returns years Impact of accounting rule and mgmt option 2004 data - Ras Vitariv With accounting and Mgmt rules Base Value 47.0 Put option Time value Margin for Embedded options 16.8 0.37% Marked to mkt Mk to Mkt 207.2 Put option Time value Margin for Embedded options 71.3 Financial returns 1.67% years 19

  21. Time value of option sensitivity Italy 2004 data - Rasvitariv Sensitivity Base case assumptions Absolute value mln euro Base premium 16.8 0.37% Increase of Equity exposure at 10% 5.9% 21.2 0.46% Bond Duration at 4 years 0.85% 6 years 38.8 Equity at 10% and bond duration at 4 years 0.96% 43.2 10y bond 3.75% 50 bp decrease of interest rate (1) 0.55% 24.1 Increase of equity volatility at 20% 0.41% 19.5 10% 20 (1) Increase of 50 bp interest rate reduces time value risk margin to 0.23%

  22. Agenda Italy Methodology and main results Portfolios characteristics Cost of options Financial risk margin Non-Financial Risk Margin Conclusions 21

  23. Financial risk margin: summary Italy Stochastic EV works in a risk-neutral framework, without any extra return for equity or other non-bond asset classes Deterministic EV takes into account equity risk premiums and the equity exposure of the company (deterministic assumptions) In a non-arbitrage framework, deterministic assumptions of extra returns must be compensated by an increased discount rate The old EV methodology achieved this compensation by adding a comprehensive risk premium (2.5%) to the risk-free The new methodology calculates the risk premium in accordance with the specific characteristics of the company portfolio 22

  24. Financial risk margin: main data Italy Mln euro - Individual business only Unit linked Traditional products Asset Management Equity risk premium 3.0% 2.5% 3.0% 2.5% 3.0% 2.5% Equity exposure 5.9% 6.0% 24% 43% 26% 43% Financial risk premium 0.79% 0.82% 0.77% 0.47% 1.60% 1.35% 2003 2004 2003 2004 2003 2004 23

  25. Financial risk margin: methodology Stochastic EV Portfolio financial returns mean The stochastic model determines average financial return in a risk- neutral environment (projecting portfolio returns utilising risk-free rates and discounting at risk-free rate) The Stochastic mean EV is equal to the deterministic Certainty Equivalent EV (projecting mean financial return and discounting at risk-free rate) Probability Stochastic EV Financial returns mean years EV Best estimate EV-risk neutral equal to CE 24

  26. The bridge from stochastic to deterministic Stochastic EV Portfolio financial returns In deterministic EV, the financial return stream of the stochastic model is adjusted to take equity risk premium into account The financial risk margin is the risk premium that neutralises the extra return introduced in the deterministic EV due to equity exposure mean Probabilty Stochastic EV Financial returns mean EV years Financial risk margin EV with equity risk premium, discounted at risk free Equity risk premium Deterministic EV Financial returns Best estimate EV-risk neutral = CE EV years 25

  27. Financial risk margin sensitivity Italy 2004 data - Ras Vitariv Base case assumptions Traditional products Unit linked Total Base premium 0.79% 0.77% Vitariv Base premium 0.71% 6% Tradit. 29% Unit L. Increase of Equity exposure by 5% 0.91% 0.90% Increase of Equity risk premium by 50 bp 3.00% 0.73% 0.95% 26

  28. Agenda Italy Methodology and main results Portfolios characteristics Cost of options Financial risk margin Non-Financial Risk Margin Conclusions 27

  29. Non-financial risks margin: summary Italy The non-financial risk margin captures all risk factors of a non-financial nature Since all expected potential losses are already factored in the deterministic assumptions (e.g. lapses curve), there is the need to measure unexpected losses The framework used by Ras to model unexpected losses is the Risk Capital Model, which it has been using since 2001 The cost of capital needed to cover unexpected losses can be considered a correct pricing for these risks 28

  30. Non-Financial risks margin: main data Italy Mln euro - Individual business only Unit linked Traditional products Asset Management Non-financial risk margin 1.41% 1.63% 2.03% 1.78% 1.65% 1.45% RC as % of reserves or assets 2.5% 1.6% 1.1% 1.1% 1.14% 1.06% Total risk capital 160 79 88 137 69 78 Of which in % 12 32 17 21 • Mortality • lapses • business 73 69 76 20 67 30 27 31 12 48 16 49 2003 2004 2003 2004 2003 2004 29

  31. Non-Financial risks margin: lapses example Risk capital stochastic model • The lapses curve used in the deterministic EV is shocked by company/portfolio specific factors (Worst Case EV) • The RC is determined as the difference between Best Estimate EV and Worst Case EV • The cost of holding this capital is deducted from the earnings stream to calculate the CE EV-CoC • The non-financial risk premium makes the new EV equal to the CE EV Worst case x 2 Lapses Determisitic EV Assumptions Best estimate years Best estimate EV = CE Non financial margin Risk capital for lapses Probability Best estimate EV = CE CE - Cost of Risk capital Worst case EV EV 30

  32. Agenda Italy Methodology and main results Portfolios characteristics Cost of options Financial risk margin Non-Financial Risk Margin Conclusions 31

  33. Final remarks Group Ras figures data are based on a stochastic model developed with the assistance of ALEF. Tillinghast has provided an independent opinion on and review of the EEV and discount rate decomposition To compare Ras results with competitors, Tillinghast measured also a CAPM-like discount rate, which is equal to 6.50%, based on 0.9 Beta and 3.00% Risk Premium The new system further enhances our existing risk management capabilities, which has been an historical competitive advantage. Now we can even better manage what has been measured 32

  34. Cautionary Note Regarding Forward-Looking Statements Certain of the statements contained herein may be statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. In addition to statements which are forward-looking by reason of context, the words “may, will, should, expects, plans, intends, anticipates, believes, estimates, predicts, potential, or continue” and similar expressions identify forward-looking statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (i) general economic conditions, including in particular economic conditions in RAS Spa’s core business and core markets, (ii) performance of financial markets, including emerging markets, (iii) the frequency and severity of insured loss events, (iv) mortality and morbidity levels and trends, (v) persistency levels, (vi) interest rate levels, (vii) currency exchange rates including the Euro - U.S. dollar exchange rate, (viii) changing levels of competition, (ix) changes in law and regulations, including monetary convergence and the European Monetary Union, (x) changing in the policies of central banks and/or global basis. The matters discussed in this release may also involve risks and uncertainties described from time to time in Allianz’s filings with the U.S. Securities and Exchange Commission Allianz assumes no obligation to update any forward-looking information contained in this release. 33

More Related