1. 1 CS-18: Risk Metrics Fred Tavan, FSA FCIA Assistant Vice President, Canada Life ERM Symposium, Washington DC July 29, 2003

2. 2 Introduction Various uses of EV Definition Methodology Pro’s & Con’s Example Application

3. 3 Various Uses of EV Information to Analysts Identification of BU’s that add/destroy value Value added by new business during year Risk exposures to value

4. 4 EV Definition EV = Shareholder’s Free Surplus +Required Capital +Value of Inforce Business -Cost of Capital

5. 5 Shareholder’s Free Surplus Excess of S/H’s equity over required capital S/H’s equity is after-tax MV of assets supporting surplus

6. 6 Required Capital Level of statutory capital that must be maintained before any distribution to S/H’s Can be affected by: –regulation –ratings considerations, or –marketing purposes

7. 7 Value of In Force Business Discounted value of after tax distributable profits Profits calculated with reference only to assets supporting current liabilities

8. 8 Cost of Capital Opportunity cost associated with holding required capital Difference between assumed future investment earnings rate on surplus and the EV discount rate

9. 9 EV Components Adjusted Net Worth Value of In Force Business Does not measure value of Future Business

10. 10 Methodology 3 General Approaches –Full Financial Projections –Aggregate Projections –Approximations Techniques Projection techniques that project future events using either aggregate or seriatim models Claims ratio techniques acceptable in some cases

11. 11 Value of In Force Full financial projections involve following steps: –setting assumptions about future experience –projecting future assets and liabilities’ cf’s –projecting required capital levels –determining future annual distributable profits –calculating pv of distributable profits

12. 12 Discount Rate Risk-free rate Risk premium addition Should be consistent with parameters of economic model

13. 13 Pro’s Consistent with finance practice of valuing free cash flows Consistent with methods used to price new products Commonly used in evaluating mergers and acquisitions

14. 14 Pro’s (con’td) Provides useful platform for risk analysis using sensitivity and stress tests and potentially stochastic analysis Gaining acceptance as a public reporting tool in Europe and Canada As a by-product, can provide useful forecasts of cash flows, earnings, etc.

15. 15 Con’s Modeling intensive Sensitive to choice of assumptions Complicated to explain to non-actuarial audience Generally not consistent with risk neutral valuation of financial products and capital markets instruments.

16. 16 Example

17. 17 Application Sensitivity Tests for : –currency –stock market levels –interest rate spreads Room for creativity in generating various sensitivity tests and scenarios

18. 18 Stochastic Modeling Possible for companies with few products operating in a single country Very challenging for multi-national companies with a wide variety of products –models would take very long to run –potential solution may be distributed computing

19. 19 SOA Website Detailed paper can be found at: –http://www.soa.org/sections/rmtf/embedded_va lue.pdf