goldman sachs financials conference „surviving in a low ...for valuation of life contracts are...
TRANSCRIPT
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Goldman Sachs Financials Conference„Surviving in a low interest rate environment“
Prof. Dr. Michael Koller, CRO and Group Chief Acturay
Rome, 18 June 2003
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Management Summary
Understanding EconomicPrinciples?
Economically Bancrupt ?
No
No
Yes
Yes
2
Are you gambling ?
Are able to take risk ?
No
No
No
Yes
Yes
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Contents
� Understanding economic principles
� Fair values et al
� Risk Taking
� Pricing New Business
� Summary
3
� Summary
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Current Problems
• Underestimated risk in asset allocations of life insurers lead to huge losses
• Low interest environment leads to the
question whether statutory reserves are
sufficient
• IASC and FASB want to introduce the
concept of “Fair Value” which needs
• The traditional methods for valuation of life
contracts are
insufficient
4
concept of “Fair Value” which needs
to be detailed
• Embedded Value as a tool for the valuation of life insurance companies
seems to be insufficient
• Changed business strategies require an
adequate pricing based on economic principles
• Aim of the Fair Value /
Valuation Portfolio
Method is to give a consistent framework
for answering / solving
these issues
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Economic
Is your company run by accounting or economically?
Statutory
Fixed
Equity Securities
Real estate
Liabilities (long-term)
Liabilities (long-term)
IAS
Real estate
Equity Securities
Liabilities (long-term)
Real estate
Equity Securities
Interest rate rise
5
Fixedmaturities
(mid-term)
Fixed
maturities
(mid-term) Statutory
Equity
Equity increases
IAS Equity
Equity decreases
Fixed
maturities
(mid-term) Economic
Equity
No impact
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Are your actuaries understanding economic
valuation?
Yie ld Curve
Base Y ear 2003
Stat Interes t 3.50%
Scenario 1 2 3 4 5 6 7 8 9 10 11
30.11.2002 0.95% 1.02% 1.25% 1.62% 1.89% 2.03% 2.18% 2.35% 2.53% 2.62% 2.71%
-25BP 0.70% 0.77% 1.00% 1.37% 1.64% 1.78% 1.93% 2.10% 2.28% 2.37% 2.46%
-50BP 0.45% 0.52% 0.75% 1.12% 1.39% 1.53% 1.68% 1.85% 2.03% 2.12% 2.21%
01. Jan 98 1.71% 1.48% 1.66% 1.76% 1.87% 2.04% 2.04% 2.20% 2.34% 2.36% 2.50%
25B P 1.46% 1.23% 1.41% 1.51% 1.62% 1.79% 1.79% 1.95% 2.09% 2.11% 2.25%
Results
Sum of Annuities 38'964'389
[E 1996/2000] Difference
M a the m a tica l S tatutorial 573'117'616
Re se rve M arket Value 556'879'280 -16'238'336
-25BP 571'956'500 -1'161'116
-50BP 587'755'665 14'638'049 1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
30.11 .2002
-25BP
-50BP
01. Jan 98
25BP
Calc Forward Rates
6
-50BP 587'755'665 14'638'049
1. Januar 1998 550'684'111 -22'433'505
25B P 565'553'755 -7'563'861
Effe ctive Group Life : Annuitie s in Pa ym e nt
0.00%
0.50%
1.00%
1 4 7 10 13 16 19 22 25 28
25BP
530'000'000
540'000'000
550'000'000
560'000'000
570'000'000
580'000'000
590'000'000
600'000'000
Statutor ial Market
V alue
-25BP -50BP 1. Januar
1998
25BP
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Overview of the actuarial process
Pricing policies
� Profitability oriented� Margin protection
� Profit testing
� Computer aided pricing
Underwriting policies� Strict result control
Actuarial competence is a major strength of Swiss Life
Prudent reserving� Regular update of tables used
7
� Strict result control
� No compromise for volume� No antiselection
Maintain and build up
further financial strength
Reinsurance policies� Add-on
� Treaties with top quality reinsurer
� Regular update of tables used
� Anticipation of future trends� Prudent choice of interest rates
Result control� Controlling
� Profit analysis
� ALM
� Embedded value
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Contents
� Understanding economic principles
� Fair values et al
� Risk Taking
� Pricing New Business
� Summary
8
� Summary
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Why Fair Values (FV)
• Traditional valuation methods focus on value creation and do not take into account the corresponding risks
• This effects become apparent in particular for
� Interest guarantees
� Implicit policyholder options (e.g. taking capital or annuity)
9
� Surrender values
� Different strategic asset allocations
• FV serve as a benchmark for additional reserves for liabilities
• FV is in line with AFP and therefore consistent with capital markets
• The application of FV in insurance leads to a competitive advantage
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Mark to market B/S: Available capital
Expected Cash Flows for a contract
-400'000
-300'000
-200'000
-100'000
0
100'000
200'000
Ca
sh
Flo
w
Premium (BoY)
Expense (BoY)
Surrender (EoY)
CF- Pattern Yield curve (ZCB)
10
-700'000
-600'000
-500'000
40 41 42 43 44 45 46 47 48 49
Age of Policyholder
Surrender (EoY)
Claims (EoY)
i_tCF_t
MV_Lia = MV(ins) - MV(outs)
Free_Capital = MV_Assets - MV_Lia
(Available Capital)
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Liabilities
11
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Contents
� Understanding economic principles
� Fair values et al
� Risk Taking
� Pricing New Business
� Summary
12
� Summary
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Required Capital: How to determine
• The following steps are required for the definition of the required risk
capital
� Definition of the risk map
� Model for the different risks
� Calculation of the probability distribution and the required risk capital
13
• In order to measure market risk capital Swiss Life uses a standard
methodology adjusted for insurance liabilities
� Market Risk: Risk Metrics (TM)
� For insurance liabilities some adjustments were required
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Risk management landscape
Financial Risk
Market Risks
Structural CFMismatch /
Liquidity Risk
Credit Risk
� Interest Rate� Equity� FX� Real Estate� Alternative Investments� Diversification
� Default� Rating Migration Activites� Counterparty / Issuer
Liquidity Risks � Trading
� Funding� Withdrawals
ALM MismatchRisk
14
Swiss Life RiskLandscape
Operational Risk
UnderwritingRisk
Failure Risk
External Risk
� People� Process and Control� Technology
� Business� External Disruption� Regulatory / tax
� Longevity� Disability� Death� Adverse Selection� Catastrophe� Frequency and Severity
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Duration mismatch properly understood
� Most life insurers have a duration mismatch
� Example Duration Assets 6 yrs, liabilities 10 yrs.
� Falling interest rates are a real
danger (Japanese situation) 0
10000
20000
30000
40000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
15
� Effects will be seen in the future if interest rates do not move upward
� Losses will be seen in the future even if today the insurer is not economically
bankrupt!
� ALM and Duration management is needed in order to survive such conditions
-40000
-30000
-20000
-10000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Income Credit P/L
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ALM
Investment Management
• Historical focus: total return• Responsible: CIO
ALM Management
• Focus: Economic Contribution• Responsible: all
CFO
16
Product Economics
• Historical focus: Economic Margin• Responsible: CRO
Commercial Aspects
• Historical focus: Volume • Responsible: CMO
CIO
CRO
CMO
CFO
EC/FV(1)
FV: Fair value (1) EC: Economic Risk Capital
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Contents
� Understanding economic principles
� Fair values et al
� Risk Taking
� Pricing New Business
� Summary
17
� Summary
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Pricing policies ensure long term profitability
and adequate reserving
• Tariff/premium rate allow
� Setting up sufficient technical reserves
� Increase of equity
� Financing of solvency
• No cross subsidies between different branches,
product lines or product generations
• Highly professional tariff rating
• Focus on profitability
• Integrated controlling
cycles
18
• In general, the same technical base used for pricing
and for reserving (exceptions for annuities)
• For coverage with no tariff guarantee (e.g. health) review of the level of tariff rate at each renewal date:
no compromises if customer does not accept
proposed tariff increase
• For new tariffs/products profit testing methods are
applied. Old portfolio monitored on regular basis
cycles
• No dumping
• Regular monitoring of
experience
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Mixed Endowment (Pricing)
0.6
0.8
1
1.2
19
0
0.2
0.4
0.6
20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64
Interest 2.75% Interest 2% Interest 3.5% Yield 30.11.2002
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Product Management: Reporting Example
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Contents
� Understanding economic principles
� Fair values et al
� Risk Taking
� Pricing New Business
� Summary
21
� Summary
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Scylla and Charybdis
22
1) Valuation needs to seek a way between Scylla and Charybdis!
2) In order to do this one needs to properly understand the Methods
3) There is not only one method which can answer each question
4) A lot of pragmatism is required
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Learning's from Arbitrage Free Pricing
• The consequent application of AFP and
RoRAC within an insurance entity enhances the insights into the business
considerably
This is in particular useful for identifying the cost of guarantees
(interest, surrender, etc)
� Application of AFP and RoRAC leads to a competitive advantage
� Traditional Business-model needs
23
All newly priced products need to
analysed as well with this measure
• The implementation of AFP and RoRAC needs well defined processes and
adequate models and a lot of know-
how!
� Traditional Business-model needs
to be changed
� Risk Management and actuarial
competence become key topics
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Discussion
24
Discussion