Transcript Slide 1

How the Stock Market may view
Market Consistent Valuations
John Hele, Deputy CFO ING Group
Market-consistent Valuation of Insurance Contracts
2nd November 2006
Key points to make
• Investors and analysts are not satisfied with
current disclosure by insurers
• EEV has not solved the issue, and perhaps
made it worse
• MCEV is viewed as a positive step toward
better valuations
• Solvency II is also seen as a big positive
• A fair value balance sheet is viewed by the
IASB as the future direction for insurance
2 November 2006
2
Basis for Conclusions
• Research reports:
• Morgan Stanley “European Insurance – What the
Market Thinks” (Sept. 5 2006)
• Merrill Lynch “European Insurance – EEV-er more
complicated” (Sept. 5, 2006)
• Bear Sterns “European Insurance – Market Consistent
or Inconsistent?” (June 12 2006)
• Fox Pitt Kelton “European Insurance – Solvency II The
Invisible Force”
• Ernst and Young: “European Embedded Value
Results” (June 2006)
• IASB Update – October 2006
2 November 2006
3
Investors find reporting Opaque
Which valuation metrics do you find most useful in valuing insurance stocks?
(Participants were allowed three responses)
RoEV to P/EV
1%
Cash earnings Residual
1%
income
1%
EV/EBITDA
Reported book 2%
New Business
Profits
1%
EV + new
business
multiple
1%
4%
Dividend yield
6%
GAAP earnings
7%
Embedded value
40%
Adjusted
measure of
book
10%
EV Earnings
12%
Sum-of-theparts
14%
• Source: MorganStanley Research
2 November 2006
4
The diversity of answers to
this question may be
illustrative of the general
opacity of reporting in the
insurance sector.
See also the comments in
relation to slide 5.
EEV Reporting has not really helped
Has ‘European Embedded Value’ reporting improved the transparency
and compatibility of life insurers’ reporting?
Significantly
deteriorated
Somewhat 3%
Significantly
improved
4%
One question that we maybe should
have (but failed to) include in our
survey would have concentrated on
investors’ ‘satisfaction’ with the
quality of current reporting. If we had
asked such a question, we suspect
that most investors would have been
critical of reporting.
deteriorated
7%
No material
change
26%
Somewhat
improved
60%
• Source: MorganStanley Research
2 November 2006
5
It is against this background that the
answers to the questions here should
be judged. The majority of
respondents believe that EEV has
‘somewhat’ improved reporting – but
we do not think that this should be
interpreted as investors yet being
satisfied with the quality of reporting.
EEV – not the answer
• European Embedded Value
• Introduced by CFO Forum to gain better disclosure and
comparability of embedded value results by European insurers
• NPV of statutory book profits less a cost of capital
• The quantity and quality of disclosure has improved significantly
• But the comparability of results is still an issue
•
•
•
•
•
•
2 November 2006
Risk Discount Rates
Non financial risks
Required Capital and cost of capital
Financial Options and Guarantees
MCEV
Source: E&Y
6
EEV- Risk Discount Rates
•Bottom Up Approach
• Typically using market
consistent approaches
• Or assigning a beta to cash
flows of business units or
products
•Top Down Approach
Source: E&Y
• WACC
Company
Method
AEGON
Allianz
Aviva
Generali
ING
Legal & General
Prudential
Skandia
Standard Life
Swiss Re
Top-down
Top-down
Top-down
Bottom-up
Top-down
Top-down
Bottom-up
Top-down
Not disclosed
Bottom-up
2 November 2006
UK In-force RDR
European In-force RDR
7,20%
6,70%
6,55%
6,00%
6,25%
7,50%
6,30%
6,80%
7,10%
7,70% Average
6,60%
7,62%
7,00%
7
5,80%
7,02%
6,10%
EEV- Non-financial risks
Company
Allowance for Non-financial Risk
AXA
CNP
Indirectly through cost of holding required capital
For non-savings contracts, 2,7% added to RDR (derived from WACC).
For savings contracts, indirectly through cost of holding required capital
0,5% added to RDRs
GBP 87m adjusted for operational risk plus allowance
in Time Value of Options and Guarantees
1% added to RDRs
Explicit allowance in non-profit fund plus allowance
in Time Value of Options and Guarantees for with-profit fund
3% p.a. cost on Economic Risk Capital
Fortis
Friends Provident
Munich Re
Resolution
Winterthur
Source: E&Y
2 November 2006
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EEV- Required Capital
• Internal model based on risk approaches
• Economic capital
• Solvency II type calculations
• S&P formula model
• For a targeted rating
• Minimum EU Solvency I
• No capital for agency costs
• A wide range of results
2 November 2006
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2 November 2006
8,5%
Not disclosed
3,6%
21,3%
7,6%
12,1%
3,7%
10,5%
5,9%
10
2,3%
Not disclosed
Resolution
Winterthur 16,2%
Standard 7,1%
Life
Swiss Re 3,2%
Skandia
3,0%
Prudential
Old Mutual 2,4%
Munich Re 7,7%
Legal & General 0,7%
Generali
ING
Fortis
Friends
Provident
CNP
AEGON
Allianz
Aviva
AXA
EEV- FOGs
TVOG/PVIF
%
Source: E&Y
EEV - Views
• ML- “EEV – Frozen in the headlights”
• “The move to EEV standards turned out to be the
antithesis of what it was intended to be…in short we
believe the new generation of embedded values has
dazed rather than dazzled investors and valuation
complexity continues to be a barrier to investing in
European insurance stocks.”
• BS- “EEV Principles have Major
Shortcomings”
• “the major problem that remains is that there is no
mechanism to link the embedded value discount rate
with the underlying risk profile of the business.”
2 November 2006
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MCEV is viewed as a positive
• BS – “MCEV is to become the standard”
• “there is a growing consensus that MCEV is the only
coherent approach”
• ML – “Expect EVs to move to a market
consistent approach”
• “this will at least give more consistency from company
to company. Against this, understanding embedded
values and how they work will continue to be a
significant challenge”
• “MCEV tends to give higher FOGs charge but lower
COC”
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Solvency II is also a positive step
• FPK “The invisible force”
• “S II will progressively transform the insurance
industry’s economics by having a significant influence
on:
•
•
•
•
•
•
Corporate strategy
Risk appetite
Product design
Pricing
Capital structure
Level and volatility of profits”
• “We think the real power of the regulation is in the
increased focus on companies to move towards risk
based product pricing and capital deployment”
2 November 2006
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Diversification based on market rates
Example: AXA Capital
International
2,3
Insurance
Total Group
Geographic diversification benefits: -35%
Diversification
11,2
benefits: -46%
P&C
1,6
Segment diversification
benefits: -17%
5,7
Life
19,1
21,9
15,5
Sum of Economic
Sum of Segments’
AXA Group
Capital of local operations
Economic Capital
Economic Capital
Source: AXA
2 November 2006
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IASB is converging to market consistency
• Phase II Accounting – October 2006 Update
• All insurance liabilities, including non-life, should be discounted
• Measurement basis for insurance liabilities should be the amount
the insurer would expect to pay today if it transferred all of its
remaining contractual rights to another entity (‘current exit value’)
• Measurement of an insurance liability should include an explicit
and unbiased estimate of the margin that market participants
require for bearing risk
• …excludes from the liability any cash flows that relate not to the
liability itself
• Discount rates should be consistent with observable market prices
for cash flows whose characteristic match those of the insurance
liability in terms of timing, currency, and liquidity
• Current exit value...reflects its credit characteristics
• An insurer should reflect acquisition costs as an expense not an
asset
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Phase II Accounting – the ultimate benefit
• Once adopted fair value accounting may be
very good for the industry
•
•
•
•
•
2 November 2006
Market consistent
Comparable
Risk based
Simple to explain exit values
Essentially MCEV anyway
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Phase II Accounting – Ultimate Work
• To create auditable and SOXed values will be
challenging compared to today
•
•
•
•
•
•
•
Fair value (exit value) of liabilities
Replicating portfolios to match assets
Par contracts
Non-life claims
Risk margins
Analysis of movement
Volatility of earnings and capital
• But will create a better industry
• And lots of work for market consistent practitioners!!!
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Key points to make
• Investors and analysts are not satisfied with
current disclosure by insurers
• EEV has not solved the issue, and perhaps
made it worse
• MCEV is viewed as a positive step toward
better valuations
• Solvency II is also seen as a big positive
• A fair value balance sheet is viewed by the
IASB as the future direction for insurance
2 November 2006
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