The Younger Members Convention Fair value 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire
Agenda A brief update on International Accounting Standards (IAS) Key issues and questions Examples –Annuity –Unit-linked –With-profits
A brief update Phase 1 To be implemented by 2005 Settles definition of insurance contracts Allows current local GAAP for contracts within definition but with additional disclosure Review of existing standards (IAS 39) for contracts outside definition Phase 2 Full IAS to be implemented by 2007
Summary of EU Position Assets IAS 39 applies in all cases Is it an insurance contract? Liabilities Local GAAP IAS 39Insurance IAS No Yes Pre 2007 Yes Post 2007
Agenda A brief update Key issues and questions Examples –Annuity –Unit-linked –With-profits
What are the issues? Can we implement IAS? Will our business even be classified as insurance? Will stochastic projections be required? How do results compare with existing methods?
Key questions and concerns What is the impact on day 1? How volatile are profits likely to be? Is the communication of results likely to cause problems? How will analysts interpret the results? What will be the impact on our share price?
Agenda A brief update Key issues and questions Examples –Annuity –Unit-linked –With-profits
Methodology & principles: A brief re-cap Asset/liability approach Prospective discounted cash flow approach Best estimate market consistent assumptions Allowance for non-market risk Entity specific value Stochastic vs deterministic
Annuity Pension annuity Single life, male age 75 Level annuity £2,500 p.a. Tax rate 30% Corporate bonds, duration matched Corporate yield curve, 5.5% flat Government yield curve, 5.0% flat
Annuity - sensitivities 0.5% downward shift in yields Yield curve steepening 0.5% increase in credit spreads
Results - Annuity
Annuity - Conclusions Day 1 fair value liability will be greater than embedded value liability Fair value profit sensitive to cash flow matching Fair value profit sensitive to change in credit spreads Different results obtained for different product classes (e.g. term assurance)
Agenda A brief update Key issues and questions Examples –Annuity –Unit-linked –With-profits
Unit linked savings Unit-linked savings Male age 40 Term 30 years Annual management charge of 1% p.a. Monthly premium £100 Initial fund size £5,000
UL Savings - sensitivities Surrenders increased by 25% Fall in equity values of 25% Expenses increased by 50%
Results - UL Savings
Unit linked - Conclusions Day 1 fair value liability will be similar to embedded value liability Volatility of profits similar under fair value and embedded value …..unless smoothing currently applied in EV Other issues –Are these insurance contracts? –What allowance should be made for future renewals?
Agenda A brief update Key issues and questions Examples –Annuity –Unit-linked –With-profits
Unitised with profit (UWP) bond Male age 55 Single premium £15,000 1% annual management charge Annual and terminal bonuses Market value adjustments (MVA) apply MVA free date on 10 th anniversary
With profits - Key issues Prevalence of guarantees Requirement to do stochastic runs Need to model management discretion
UWP Bond - sensitivities A fall in equity values of 25% An increase in implied volatility of 5%
UWP Bond - sensitivity results
UWP Bond - further sensitivities Dynamic reversionary bonus (RB) rule Dynamic asset allocation Reduced equity backing ratio (EBR) Static surrender rates
UWP Bond - sensitivity results
UWP - Conclusions Day 1 impact will depend upon cost of guarantees Future volatility will depend upon: –Matching of assets –Management discretion –Policyholders reasonable expectations
Wider implications Regulatory impact? The death of embedded values? Better understanding and quantification of risks
Summary Day 1 impact will be significant but will vary from product to product Results/profit will be more volatile
Comments/questions …
The Younger Members Convention Fair value 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire