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© Aviva plc - ConfidentialPresentation title Slide 1 15/04/2014 Implications of Realistic Reporting - The Lure of Mathematics Mike Urmston Chief Actuary Norwich Union © Aviva plc
© Aviva plc - ConfidentialPresentation title Slide 2 15/04/2014 Agenda 1. Realistic Reporting -State of Play -Implications for Risk Management -Implications for Policyholders - Implications for Intermediaries 2. Individual Capital Assessments - State of play - Implications of early results - Implications for Risk Management 3. Role of the Board
© Aviva plc - ConfidentialPresentation title Slide 3 15/04/2014 1.1 Realistic Reporting - State of Play Different stages of model development -semi-stochastic, non-dynamic, dynamic Model sophistication - use of different ESGs - degree of management action - degree of policyholder action Power - hardware and software development - number of model points Linkage to PPFM - definition and discretion/practice tightening Audit standard - phased progress to undefined level Speed versus Accuracy - Penrose accounting
© Aviva plc - ConfidentialPresentation title Slide 4 15/04/2014 1.2 Realistic Reporting - Implications for Risk Management Much improved discipline for the management of risk - actuarial judgement now subject to vigorous challenge Much more than a valuation method - a methodology that is all intrusive on the future management of risk - a methodology that has a major impact on our customers Risk management strategies need to be clearly defined Available capital limits level of risk borne by funds - policyholder and shareholder capital
© Aviva plc - ConfidentialPresentation title Slide 5 15/04/2014 1.2 Realistic Reporting - Implications for Risk Management (continued) Key guarantees - need very careful attention - minimum maturity values - no MVR points and options - guaranteed annuity options, S32 annuities Key principles - very influential on approach - degree of real asset exposure - degree of smoothing of returns - amount of risk sharing
© Aviva plc - ConfidentialPresentation title Slide 6 15/04/2014 1.2 Realistic Reporting - Implications for Risk Management (continued) Other changes to balance the books - reduce annual bonuses (future guarantee costs) - payouts much more tightly aligned to asset shares - future smoothing policy - charges to pay for guarantees - more regular reviews of surrender or transfer values - all subject to PPFM and treating customers fairly
© Aviva plc - ConfidentialPresentation title Slide 7 15/04/2014 1.2 Realistic Reporting - Implications for Risk Management (continued) Investment policy - changes in place or under development - swaptions to hedge GAOs - reductions in Equity Backing Ratios - differential investment/credit risk strategy for estate - differential investment for different groups of policyholders (subject to PPFM) - duration matching of fixed interest - level of credit risk and duration
© Aviva plc - ConfidentialPresentation title Slide 8 15/04/2014 1.2 Realistic Reporting - Implications for Risk Management (continued) Formulate plans to deal with future shocks - volatility spikes - market crash - credit crunch Use of derivative and dynamic hedging strategies to protect funds in extreme conditions Possibility that all occur at once? - mathematics doesnt always work - LTCM!
© Aviva plc - ConfidentialPresentation title Slide 9 15/04/2014 In a strict sense, there wasnt any risk - if the world had behaved as it did in the past The question….is whether the LTCM disaster was merely a unique and isolated event, a bad drawing from natures arms; or whether such disasters are the inevitable consequence of the Black-Scholes formula itself and the illusion it may give that all market participants can hedge away all their risk at the same time Merton Miller, Nobel Laureate
© Aviva plc - ConfidentialPresentation title Slide 10 15/04/2014 1.3 Realistic Reporting - Implications for Policyholders Did anyone ask them? Shareholders/Mutuals likely to be risk averse - nature of regulatory pressure Lower risk means less volatility in returns - BUT less rewards, inconsistent with expectations Pooling approach to the sharing of risk across generations has been lost FSA implementation retrospective and rushed - Equitable panic With profits would never have started on this basis, and old concept unlikely to survive for future new business for any but the strongest Smoothed managed funds may have some future
© Aviva plc - ConfidentialPresentation title Slide 11 15/04/2014 1.3 Realistic Reporting - Implications for Intermediaries Customers will see lower guaranteed bonuses, falling payouts, active MVRs Low EBRs mean more certainty but little upside potential Policyholders trapped in poor performing funds Dangers of misselling and growth of complaints Intermediaries looking to switch/offer alternative investment vehicles Need for help as to what to advise customers
© Aviva plc - ConfidentialPresentation title Slide 12 15/04/2014 2.1 Individual Capital Assessment - State of Play Stress and scenario tests generally used Consistency with 99.5% probability of solvency within one year - economic generators used for market risks - credit risk needs careful approach - more difficult to define for other types of risk e.g. annuitant mortality, persistency, expenses
© Aviva plc - ConfidentialPresentation title Slide 13 15/04/2014 2.1 Individual Capital Assessment - State of Play (contd) Risk based capital models can be run to provide support to some of the tests being used - run off approach or test solvency yearly? Correlation matrix key to diversification benefits - degree of independence of risk, more research needed Difficult areas include operational risk and pension scheme deficits
© Aviva plc - ConfidentialPresentation title Slide 14 15/04/2014 2.2 Individual Capital Assessments - Implications of early results Current non-profit statutory valuations look very strong. Capital requirements likely to be lower for protection business and unit-linked savings Guarantees will require more capital. Annuities likely to see higher capital requirements in view of risks involved Arguments for realistic reporting for non profit business - future FSA agenda. Possible waivers? Capital utilisation and Returns on Capital likely to be impacted by new assessment regime.
© Aviva plc - ConfidentialPresentation title Slide 15 15/04/2014 2.3 Individual Capital Assessments - Implications for Risk Management Development of strategies to manage non-market risks less advanced Level of exposure and risk appetite need more definition Use of reinsurance and capital markets to reduce risk e.g. catastrophe risk, annuitant mortality risk? Systems and controls to manage operational risk No natural markets developed yet. Can we envisage mortality or persistency swaps between insurers and reinsurers?
© Aviva plc - ConfidentialPresentation title Slide 16 15/04/2014 3. Role of the Board Board has responsibility that there is no significant risk that the firm is not able to meet its liabilities Board needs to understand its risks far more and the likelihood - probability distribution - of these risks Board needs to be satisfied on the techniques used and the assumptions made Board must ensure that management actions are consistent with what with profit policyholders are expecting and published practice Such complex issues require far more training. Directors and non executive directors need to understand far more detail about the risks involved - is this reasonable Understanding mathematics is at the heart of the Boards agenda
© Aviva plc - ConfidentialPresentation title Slide 17 15/04/2014 Markets can remain irrational longer than you can remain solvent John Maynard Keynes
© Aviva plc - ConfidentialPresentation title Slide 18 15/04/2014
© Aviva plc - ConfidentialPresentation title Slide 19 15/04/2014 Thank you
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