The Financial Crisis and its implications for the insurance industry & the actuarial profession

The Financial Crisis and its implications for the insurance industry & the actuarial profession XIX. Altenburger Gyula Szimpózium Balatonvilágos, 22nd of May 2009 Generali Deutschland Holding AG László Hrabovszki Nora Gürtler

The financial crisis and its implications on insuranceAgenda • Phases of the Financial Crisis • Implications on products and sales activities • Implications on value based management in the context of Solvency II • Position of the actuaries – today and in the future The Financial Crisis and its implications / 22.05.2009 / Generali

In 2008, the capital markets only went down… Source: Frankfurter Allgemeine Zeitung, 05.10.2008 The Financial Crisis and its implications / 22.05.2009 / Generali

Subprime crisis Phase of uncertainty Banking crisis Economic crisis The financial crisis has affected the insurance industry step by step: the four phases of the crisis • Further stock market losses • Impacts on the real economy • Economic stimulus packages • End of the crisis not yet in sight • Default of finan-cial institutions • Brakdown of interbank trading • Loss of confidence • Plunging of stock prices • Rescue packages issued by the states Dax 30.06.07 • High volatility at the markets • Explosion of commodity prices • Huge and omni-present uncertainty • US real estate crisis • Default of subprime credits • Strong losses at the stock markets in January 2008 Dax 30.12.08 The Financial Crisis and its implications / 22.05.2009 / Generali

Subprime crisis & pase of uncertainty: The German insurance industry was only affected indirectly by the development of capital market indices Subprime crisis • German insurance industry was only marginally affected – hardly any direct investments in subprime papers • Excellent year 2007, in spite of the high volatility at the capital markets in the second half year 2007 • Even at the beginning of 2008, the German insurance companies were only touched indirectly by the negative development of equity indices • First writedown of shares in 1Q 2008 Phase of uncertainty • Operational insurance business not yet touched by the developments at the capital markets • Insurers still expected a „common“ investment result for 2008 • 1 HY result 2008 already burdened by impairments due to regulations for the writedown of shares The Financial Crisis and its implications / 22.05.2009 / Generali

Since liquidity is not an issue for insurers, the situation of the German insurance sector is not comparable to that of the banking industry Banking crisis • Even during the aggravation of the crisis, the German insurance sector is still only affected indirectly by the developments at the capital market • Insurers limit their risk by a conservative asset allocation allowing only for an average equity backing ratio of approcimately 10% • Single defaults of banks lead to writedowns also for insurers, but still of limited relevance compared to the market-wide portfolio • Due to recurrent premiums leading to a steady flow of premium income, liquidity is not an issue for insurers • No solvency problems in the insurance sector • None of the German insurers needed benefits from the rescue packages issued by the state – on the contrary: the sector participated in the rescue package for the bank „Hypo Real Estate“ • Policyholder funds are safe – feeble signs of customer uncertainty visible, but in general no collapse of new business in sight • Q3 2008 results burdened by heavy impairments – almost all insurance companies refrain from forecasts for forthcoming results due to the volatilities at the capital markets The Financial Crisis and its implications / 22.05.2009 / Generali

The financial crisis heavily affected the market capitalization of banks - ranking of banks by market capitalization * Source: Frankfurter Allgemeine Zeitung, 06.02.2009 The Financial Crisis and its implications / 22.05.2009 / Generali

Extension of the financial market crisis to the real economy leads to an economic crisis in 2009 and difficult business conditions Economic crisis • Broadening of the crisis to the real economy yields negative impacts on private consumption and investments • New political and economic risks from high public debt • Increasing guarantees issued by the state • Consolidation of the banking sector & revision of the business model • Current forecasts and possible scenarios • Insurance sector affected in 1Q 2009 by a noticeable decline in new business • 2Q 2009 shows the first signs that the decline slows down, but it is too early to draw any conclusions The Financial Crisis and its implications / 22.05.2009 / Generali

Consequences of the financial crisis Implications of the financial crisis on distribution and product strategy Dax 30.06.07 • Which parts of the population are affected most? • Are the needs of different customer segments changed by the crisis? • Will the demand for insurance products change between segments? • What is the expected development of the available income? • Will there be an increase in „moral hazard“ problems in the recession? Dax 30.12.08 The Financial Crisis and its implications / 22.05.2009 / Generali

In a difficult environment, insurers have the key competences to respond to current and future challenges Pressure on prices and profit margins Limited resources and caution from customers due to the economic crisis Difficult situation at the capital market Demographic development Core competences of insurers: • Guarantee • Safety • Realistic return • Calculation of biometric risks • Financial advice Challenging legal and regulatory framework „War for sales forces“ and continuous need to optimally support them Competition with the banking sector and fund industry Solvency II process and risk management requirements The Financial Crisis and its implications / 22.05.2009 / Generali

Factors of success for 2009: Detecting the needs of clients and approaching them with the right concept Respond to the client‘s wish for comfort and convenience by multi-segment solutions & assistance Holistic approach – advise the client with all his needs In today‘s complex & ever-changing financial environment, most clients need guidance & support Take into account both the client‘s need for safety and his desire to participate in the returns Clients &distribution Increased need for building up retirement provisions and covering biometric risk Increased price consciousness of clients and wish for tax optimization The Financial Crisis and its implications / 22.05.2009 / Generali

Factors of success for 2009: Innovative products show the core competence of insurers Increase in the transparency of products and differentiation by customer segments Multi segment solutions: Annuities, healthcare & assistance New types of products offer safety and oppor-tunities: Further differen-tiation of guarantee concepts Increase in flexibility: Single premiums and varying premiums gain importance Product development Unit linked products with guarantees remain interesting Covers against biometric risks and annuity products become interesting The Financial Crisis and its implications / 22.05.2009 / Generali

Factors of success for 2009: Facing the competition in the market by strategy and operational excellence Continued pressure on prices and profit margins requires cost efficiency Global players have advantages in an environment becoming more and more global Respond to the competition with the banking sector by product innovation Cultivate and use the insurers‘ image of financial advisors with a solid background Competitionin the market Use tax advantages for insurance products Identify customer segments and offer them tailored products The Financial Crisis and its implications / 22.05.2009 / Generali

Disregarded risks have gained importance: e.g. financial guarantees (Germany) Increasing importance of financial options & guarantees in the German market - these are not reflected in „traditional“ deterministic calculations 10 year government bond ø Total crediting rate German market ø Guarenteed crediting rate German market ø Net interest return German market Guaranteed crediting rate new business The difference is an indicator for the insurer‘sinterest rate risk in % The Financial Crisis and its implications / 22.05.2009 / Generali

Economic scenario generator arbitrage free, market consistent scenarios liability model Set of management rules asset model LI products Explicit RfB Options/guarantees Asset classes SAA profit sharing P/H S/H Risk assessment dynamic adjustment of the SAA Declaration of profit sharing Hence, for risk based management (RBM) & value based management (VBM), a stochastic model framework is necessary The Financial Crisis and its implications / 22.05.2009 / Generali

New concepts require a common stochastic platform Market consistent EV (McEV) Pricing/ Product Design ALM Stochastic Model Corporate Planning Value Based Management IFRS 4 Phase II Risk transfer Solvency II Internal Risk Management The Financial Crisis and its implications / 22.05.2009 / Generali

6,5% 15.09.2008bankruptcyof Lehman Brothers 6,0% 5,5% 5,0% Greece 4,5% Italy 4,0% 3,5% Germany 3,0% 2,5% 2,0% 01.01.2007 01.01.2008 01.01.2009 Germany Italy Greece The financial market crisis results in huge differences in the average returnof European government bonds The Financial Crisis and its implications / 22.05.2009 / Generali

Factors of success for 2009: Capital management & performance management as a response to Solvency II Asset liability manage-ment (duration matching, assessment of profit sharing options) adds to the measures Efficient and successful asset management as the key factor of success Financial management becomes more com-plex, due to Local Gaap, IFRS & market valuation requirements With Solvency II on its way, internal models are more important than ever Management of capital & return Value based management (VBM) and risk based management (RBM) In view of IFRS 4 phase II, market valuation of liabilities is approaching The Financial Crisis and its implications / 22.05.2009 / Generali

New Business Value (NBV) and profitability of different product groups- analyses form the basis for the implementation of VBM in practice Dec. 2006, Life new business and performance ratios € m CoC € 27 m 39 156 129 New Business Value (NBV) 1 26 29 43 13 6 Endowment Annuities Term/ disability Riester Corporate pensions Unit- linked 2 Total NBV before CoC Total NBV after CoC after CoC before CoC APE PV premiums 39 296 97 880 136 1,200 255 1,794 150 1,114 208 1,751 885 7,035 885 7,035 14.7% 13.0% 31.7% 11.5% 17.5% 18.7% 17.6% 14.6% NBV/APE NBV/PV premiums 1.9% 1.4% 3.6% 1.6% 2.4% 2.2% 2.2% 1.8% 1 NBV in representative rounded figures 2 incl. net fund management fees The Financial Crisis and its implications / 22.05.2009 / Generali

Application of profit tests and NBV in value based management Identify value drivers (e.g. by sensitivity analyses) • Costs • Strategic asset allocation • Lapse rates • Options and guarantees within products Push of profitable products • Push profitable existing products • Push product innovation • Implement systematic profit tests in the product development process Focus on profitable customers • Identify profitable customer segments • Push cross selling there Maximize the risk return profile of your business The Financial Crisis and its implications / 22.05.2009 / Generali

The Solvency II directive has just been agreed Recent CEIOPS consultation papers Main contents of the Solvency II directive • Best estimate liability • Segmentation of technical provisions • Counterparty default risk • Ancillary own funds • Future premiums • Financial risk mitigation • Future management actions • System of governance • Transparency and accountability of supervisors • Valuaion of assets and other liabilities • Special purpose vehicles • Internal model approval process • Solvency II directive has just been agreed by the European Parliament and Council • Time frame: • Level 2 advice: until the end of 2009(3 waves of CEIOPS consultation papers) • QIS5: in April 2010 • Target implementation date: October 2012 • Major changes compared to 2007: • Omission of group support, but recognition of diversification effects at group level • „Equity dampener“ as an option • Allowance for one year of new business • MCR based on a linear combination with floor and cap The Financial Crisis and its implications / 22.05.2009 / Generali

Implications of the financial crisis and of the Solvency II process on the role and responsibilities of actuaries Financial crisis Current and future role of actuaries • Re-establish confidence in models by a better understanding • Integrate ALM analyses into decision making • Demand for understandable and manageable products - and for the people who build them Current role of actuaries • Position of the Appointed Actuary in life insurance Actuaries gain importance - future profile of the actuarial profession: • Actuaries are experts for internal models (most of them with a stochastic approach): • Theory • Implementation • Analysis • Reporting • Actuaries act as risk managers • ALM analyses conducted jointly with asst managers • Responsibility for financial reporting (MCEV, market value of liabilities) Solvency II increasingly requires independence and objectivity of actuaries & risk managers Solvency II process • Solvency II framework directive has been approved • Solvency II requires internal models at least for the big groups, usually based on stochastic simulations • Enterprise Risk Management (ERM) process set on its way IFRS 4 Phase II • Market valuation of liabilities • Economic balance sheet The Financial Crisis and its implications / 22.05.2009 / Generali

The Financial Crisis and its implications for the insurance industry & the actuarial profession