AXA s approach to Asset Liability Management. HELVEA Insurance Capital Adequacy and Solvency Day April 28th, 2005

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1 AXA s approach to Asset Liability Management HELVEA Insurance Capital Adequacy and Solvency Day April 28th, 2005

2 ALM in AXA has always been based on a long-term view Even though Solvency II framework is not well defined yet, the 3 pillars' approach should bring regulatory framework closer to economic reality. AXA takes a long term approach in Asset Liability Management, as illustrated by the stability of the asset allocation. This Asset Allocation is only based on optimal long-term value creation under stringent risk constraints: Solvency requirements Economic solvency Earnings volatility More consistent after the introduction of Solvency II -2-

3 AXA s ALM starts as a local process, but a Group approach allows to optimize decisions and provide consistency Responsibilities of the Group Definition of Group Limit exposure Definition of consistent analytical framework (Economic Capital) Validation of strategic and tactical benchmarks Authorize the use of non Group manager Monitoring of asset managers performance Control Risk exposure Insurance Liability Asset Management Responsibilities of the local entities Asset/ Liability studies Strategic Asset Allocation Responsibility of the Insurance Company (Investment Department) Variation around the strategic asset allocation Portfolio Construction/ Alpha generation/ Security selection Reporting / Control Responsibility of the Asset Management Company Management Contract -3-

4 This leads to a global ALM view Market value of Consolidated Invested assets as of 12/31/04 (Euro bn) 423 P&C, International, Reinsurance & Non Guaranteed Life Others All risks and rewards for Risks and rewards split between policyholders All risks and rewards for Shareholders policyholders and shareholders Separate Account 114 P&C 39 Life Participating 178 (Unit linked) International Insurance & Reinsurance 9 Life Non Participating with guaranteed rates 20 UK With Profit 29 Asset Management, Holdings & Other financial services 12 Non Par. without guaranted rates 9 Asset allocation Other Liabilities 13 Asset allocation Fixed Income 62.0% Fixed Income 72.0% Equities 17.0% Equities 10.0% Mortgage, policyholder loans 2.0% Mortgage, policyholder loans 8.0% Real Estate 5.0% Real Estate 4.0% Cash 14.0% Cash 6.0% Unrealized capital gains Euro bn 3,3 5.5% Unrealized capital gains Euro bn 15,3 7.0% -4-

5 ...and to consistent ALM concepts and processes throughout the Group Shareholder equity and margins net of the debt Equities 16% Fixed income & alt. net of debt 84% SH equity and margins Economic Excess Assets 65% Economic Capital 35% Duration in years Life Non UL Assets 6,6 Liabilites 7,7 P&C 5,3 6,1 16% of SH Equity and margins are invested in equities 25% of Economic Excess Assets are invested in equities Group 6,0 7,0 No Equity leverage Prudent Duration Management Solvency II should be the opportunity to better capture these economic realities in the regulatory framework -5-

6 Impact of Solvency II on ALM in Life companies is still unclear ALM in Life is mainly about correctly measuring and evaluating embedded options, explicit or implicit, in the liabilities McCaulay duration is a good measure of sensitivity of financial assets to interest rates, but it is not applicable to liabilities, because best estimate cash-flows do not capture the effect of embedded options (explicit or implicit) in Life contracts Option-Adjusted duration should be the rule, based on stochastic modeling techniques, in order to fully capture : the effect of guaranteed rate the effect of lapse the effect of profit sharing strategy Therefore, ALM in Life must be approached market by market and business by business. The impact of Solvency II on Life companies will depend on how liabilities are treated market by market -6-

7 Let s focus on our P&C business At first glance, ALM in P&C boils down to an asset allocation problem, aiming at maximizing total return under risk constraints : Solvency requirements Management and shareholders risk aversion Earnings volatility Liquidity And therefore, long-term value creation is mainly determined by Equity allocation Duration management However, these asset allocation decisions are in fact driven by ALM considerations, especially as far as pricing of new contracts is concerned -7-

8 Equity Allocation in P&C is determined in order to optimize shareholder s value Equity allocation is determined based on : Asset backing reserves invested in order to minimize risk for policyholders Asset backing capital invested in order to optimize risk-return trade-off with insolvency risk <1% Mix equity-bond 0-100% 25-75% 33-66% 50-50% Capital Probability to fall below 100% (over 4 ys) 0% 0,5% 1,0% Optimal equity allocation at 1/3 of shareholders equity 2,0% EC Asset Mix Sensitivity on EC & Required Assets Optimal Range RA P&C reserves % 10% 20% 30% 40% 50% 60% % of Equity Optimal equity allocation at 15%-20% of P&C reserves in a stand-alone basis EC RA Leading to an average equity exposure of 20%-25% at a single entity level. -8-

9 However, at the Group level, optimal equity allocation is lower than at an individual company level The lower the volatility of the claims, the lower the optimal equity backing ratio Probability 0,3% 0,3% 0,2% 0,2% 0,1% 0,1% 0,0% Distribution of liability cash flows Single entity Group Claims Volatility of claims at Group level Volatility of claims at Entity level Economic Capital Economic Capital vs EBR Single entity Group 0% 10% 20% 30% 40% 50% 60% Equity backing ratio Therefore the optimal equity backing ratio for the reserves at the Group level (10-15%) is lower than the average equity backing ratio across entities (15-20%). This leads to an optimal total equity allocation close to 20% at the Group level (reserves and capital) Solvency II should recognize that equity, from a risk standpoint, is a sound investment. -9-

10 Further reduction of risk is possible by restricting the investment universe to low-risk stocks Investment in equity, which in the long-term outperforms bonds, is a natural investment for insurance companies But, because of solvency constraints, and because of shareholders expectations regarding earnings stability, investment in low-risk stocks should be favored A screening process solely based on risk criteria has been implemented in order to limit equity exposure to low-risk stocks ( value characteristics) Europe ex-uk equity market, AXA Universe and 7-10 year Govt bonds Cumulative returns and this has no significant impact on performance -10-

11 Duration Management is a key aspect for optimal value creation The duration of the fixed income portfolio should be based on the duration of liabilities, but under which scenario? Run-off : 2-5 years Renewals : 5-7 years New business : 7-10 years + This depends on the sensitivity of future cash-flows to interest rate In a normal interest rate curve, the duration management should be : Duration as long as possible to maximize investment return While limiting pricing risk associated with future cash-flows. This should 102 be assessed market by market 100 Regression between premiums and the 1-year yield: Future premiums do not depend on the interest rate environment Market premiums In AXA, the P&C fixed income portfolio is invested between 3.5 years (UK broker-led market) and 7 years (France tacit renewal system). These market specific features should be captured by the Solvency II framework ,5 4 4,5 5 5,5 1-year Yield -11-

12 What s next in Asset Liability Management in P&C (1/2) Insurance is a long-term business and should be approached as such, especially as far as ALM and asset allocation are concerned : Long-term asset return Insurance cycle Economic cycle AXA s approach has always been to stick to this long-term approach. Our equity allocation has remained stable over the past 6 years and our duration gap has remained close to 1 year, both in Life and Non-Life ALM should be driven by economic considerations. Accounting and solvency rules should be seen as embedded constraints In particular, the impact of IFRS is now well assessed and hasn t led to significant change in asset allocation and investment management -12-

13 What s next in Asset Liability Management in P&C (2/2) The impact of Solvency II is not clear yet but, Solvency II should remain close to the original concept and should reduce the gap between the regulatory framework and economic reality. This should result in better asset allocation, and capital allocation, and therefore increased value creation for shareholders and policyholders -13-

14 Cautionary Statements Concerning Forward-looking Statements Certain statements contained herein are forward-looking statements including, but not limited to, statements that are predications of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties and can be affected by other factors that could cause actual results and AXA s plans and objectives to differ materially from those expressed or implied in the forward looking statements (or from past results). These risks and uncertainties include, without limitation, the risk of future catastrophic events including possible future terrorist related incidents. Please refer to AXA s Document de Référence for the year ended December 31, 2004 and AXA's Annual Report on Form 20-F for the year ended December 31, 2003, for a description of certain important factors, risks and uncertainties that may affect AXA s business. AXA undertakes no obligation to publicly update or revise any of these forward-looking statements, whether to reflect new information, future events or circumstances or otherwise. -14-

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