evolution of ev - acsw of ev brian holland, fsa, maaa avp & actuary ©2009 munich american...

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Evolution of EV

Brian Holland, FSA, MAAAAVP & Actuary

©2009 Munich American Reassurance CompanyProprietary Information

Agenda

Overview

Are statutory and Generally Accepted Accounting Principals (GAAP) enough?

Embedded Value

What

Why

Economic Risk Capital (ERC) rolep ( )


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Take Aways

To cover why Embedded Value methodology came about and has continued to develop:

“Traditional” Embedded Value (TEV)

European Embedded Value (EEV)

Market Consistent Embedded Value (MCEV)

Economic Risk Capital (ERC)


Embedded Value: Common Criticisms

Only earn risk free rate (RFR), use fake assets (MCEV)

No central rules (make your own?)

Changing rules

Volatile

Moral hazard

Market criticisms…


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Embedded Value Development Summary

Development ReasonUS GAAP Statutory too conservative

T diti l E b dd d V l N i t ti l GAAPTraditional Embedded Value(TEV)

No international GAAPGAAPs inconsistentGAAPs ignore statutory restrictions

European Embedded Value(EEV)

Lack of general rules in TEVFinancial options & guarantees (FOG)

European Market Consistent Asset valuationsEmbedded Value(EMCEV)

Insurance cash flowsRisk measurement & Solvency II


Agenda

Overview


Embedded Value

What

Why



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Statutory and GAAP Limitations

Inconsistent between countries

Inconsistent between productsp

Inconsistent between time periods

Principles-based approach (PBA)

Loss recognition


Agenda

Overview


Embedded Value

What

Why



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Embedded Value: Overview

Value “embedded” in statutory balance sheet

Equity that is not shown

The value of assets you expect to keep

Value of inforce business

Not company value – which includes new business value


Embedded Value: Changes from one year to next

Contributed or distributed funds

Currency exchange rate changes

EV earnings

Expected return

New business (NB) added

Old business (OB) changes

o Asset value changesg

o Insurance events over past year

o Revised expectations of future


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Example: 2007 Munich Re Group Life EV Earnings

http://www.munichre.com/app_resources/pdf/ir/publications/presentations/2008_03_11_embedded_value_en.pdf


Embedded Value Versions

Traditional Embedded Value

European Embedded Value

European Market Consistent Embedded Value

Each is in response to particular needs.


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Traditional Embedded Value

When

2000 earnings year for Munich Re Group Life

Why

Value “embedded” in statutory balance sheet

Comparability

What

Present value of statutory free cash flows

Discounted at Weighted Average Cost of Capital (WACC) like with Capital Asset Pricing Model (CAPM)


European Embedded Value

When

2005 earnings year for Munich Re Group Life

Why

First ever published, general standard

Consistency among CFO Forum companies

What

Improved consistency of disclosures

Financial options and guarantees: range of scenarios


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Market Consistent Embedded Value 1.0

When

Munich Re Group Life: 2005 in addition to EEV

Why

Consistency with financial market prices

What

Assets at market to account for credit and other risks

Explicit value reduction for insurance risks


European EV / Market Consistent EV 1.0:Pulling it Together

Assets: at market value

Insurance contract cashInsurance contract cash

Best estimate at risk free rate (RFR)

Must take premiums, pay claims & administer business

Note: value independent of assets

Insurance risks

Investment income taxed extra; pay asset manager feesInvestment income taxed extra; pay asset manager fees

Uncertainty: 1% haircut / year until take money out


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When

2011 earnings year for CFO Forum members

Why

Risk not just function of time

Solvency II “Use Test”

Consistency of asset valuation; presentation

Risk premia at WACC = market value? Maybe not.



What

Assets, insurance: same for Munich Re Group Life

Risk charges improved

o Now on Economic Risk Capital (ERC)

o Less dependence on local statutory frameworks

o Still have statutory “parking lot” charge


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Embedded Value Development Summary

Development ReasonUS GAAP Statutory too conservative

T diti l E b dd d V l N i t ti l GAAPTraditional Embedded Value(TEV)

No international GAAPGAAPs inconsistentGAAPs ignore statutory restrictions

European Embedded Value(EEV)

Lack of general rules in TEVFinancial options & guarantees (FOG)

European Market Consistent Asset valuationsEmbedded Value(EMCEV)

Insurance cash flowsRisk measurement & Solvency II


Embedded Value: Common Criticisms Redux

Only earn risk free rate (RFR), use fake assets (MCEV)

No central rules (make your own?)

Changing rules

Volatile

Moral hazard

Market criticisms…


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Only Earn Risk Free Rate?

Not “assumption” in MCEV; but often use term

Point: show assets at market

Means: asset, insurance values independent

EMCEV Principle 12:

“…all projected cash flows are valued in line with the prices of similar cash flows that are traded on the open market.”


Only Earn Risk Free Rate?

“Average future investment returns and discount rates areassumed to be that of a ‘risk-free’ investment.

Not what we actually expect to happen, but a mathematicaltrick to get the right answer while making the calculationseasier.”

-CFO Forum MCEV Launch Presentation


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Market Consistency: Economic Assumptions vs. Investment Variances

Munich Re Group Life: changed in 2007

CFO Forum: changing in 2011

EMCEV Principle 17.3.28

“There is no requirement to separately discloseeconomic experience variances and changes ineconomic assumptions… an explicit split is not a naturalsubdivision.”

Reported under: “Economic Experience Variances”Reported under: Economic Experience Variances


Munich Re Group Life: 2006

http://www.munichre.com/app_resources/pdf/press/press_releases/2007/2007_05_04_eev_disclosure_en.pdf


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Munich Re Group Life: 2007

http://www.munichre.com/app_resources/pdf/ir/publications/presentations/2008_03_11_embedded_value_en.pdf


Other Embedded Value Discussion Points

Lack of rules

EEV, MCEV principles

Changing rules

GAAP, statutory also changing

Volatile results

To show, or not to show?

Moral hazard

Results reviewed; will be even higher scrutiny


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Criticisms of Financial Markets

Irrational, herd-like

Volatile

Risk and return

We take risk to get more return

Otherwise, would not be much point

I won’t deny…


Why Consistency with Market?

The alternative: everyone has own value

Market is where we haggle assumptions out.

If disagree, bet now and profit later.

You’ll earn spreads – over time as others agree.

My view: “Not right, just real.”


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Agenda

Overview


Embedded Value

What

Why



Economic Risk Capital: Definition and Role

Definition

Risk tolerance (99.5% value at risk (VaR) of present value (PV))

Over a horizon (one year)

Role

Charge for nonhedgeable risks in EMCEV

Basis for investment: what you could lose, not what’s on y ,deposit


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Value at Risk (VaR): Example

0.007

0.008

0.009VaR is difference from expected...

0.001

0.002

0.003

0.004

0.005

0.006

Prob

ability

... with a 1 in 200 chance


0

0 50 100 150 200 250 300 350

Present Value of Cash

ERC Calculation: Overview

Experience shocks running out over time

Impact: risk to value of cash

Future events: independent?

Lapses and morbidity?

Reflect management reaction to assumption change


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Remaining Possible InconsistenciesInsurance Models

Best estimates among companies

ERC modelsERC models

Business Models

MCEV Principles Launch:“Analysts may need to place more focus on MCEV operating earnings rather than Value of New Business alone.”

“A product with low Value of New Business might generate good returns over time; e.g. annuities.”


‘Holy Grail’ Found?

“No single valuation framework will perfectly answer all interesting questions.”

CFO F MCEV L h P t ti-CFO Forum MCEV Launch Presentation


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Thank you for your attentionThank you for your attention.


evolution of ev - acsw of ev brian holland, fsa, maaa avp & actuary ©2009 munich american...

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