ALM in UK Life. DRAFT 12 January 2011 V1

Transcription

1 ALM in UK Life WP & Annuity strategy t John Lister DRAFT 12 January 2011 V1 1

2 ALM in UK Life Summary Asset and Liability management is at the core of what we do This combined with the quality of our credit portfolio Gives confidence in the resilience of our balance sheet, total IFRS earnings and OCG capabilities 2

3 UK Life WP funds 53bn in-force participating business at UKL ASSET SHARE & COG Estate WPSF ( 21.4bn) AS + COG Estate OWPSF ( 3.7bn) AS + COG Estate PM ( 1.9bn) ASSET SHARE COG RIEESA NWPSF ( 25.6bn) 3 x WP 90:10 funds with a total of 27 billion of liabilities IFRS earnings are 10% of total WP bonus (c. 30 million p.a.) Shareholders are exposed to the risk of: Lower bonus rates Burn through risk from CoGs Burn through risks are minimal Post reattribution fund with 24.3 billion of policyholder liabilities The reattributed estate (RIEESA) of 1.3 billion and assets backing guarantees of 2.3 billion are now owned by shareholders Shareholders are directly exposed to risks in CoG and RIEESA The RIEESA is recognised as a shareholder asset on the balance sheet Source: IFRS as at HY10 Key: AS Asset share CoG Cost of Guarantees RIEESA Reattributed inherited estate external support account 3

4 Reattribution deal A good deal for policyholders and for shareholders Assets 25.6bn Asset share 22bn Policyholder owned RIEESA 1.3bn Cost of guarantee 2.3bn Shareholder owned Shareholders paid 471 million for the estate worth 1.1 billion and CoG of 2.3 billion at E-day Have the right to write new non-profit business in the RIEESA subject to certain restrictions Expect to use 650 million over 5 years, enabling profit from the existing non-profit book to be used to support dividends rather than being reinvested in new business Generates recurring IFRS operating earnings of 120 million p.a. from Expected earnings on RIEESA assets Unwind of time value of CoG Expect further non-recurring profits as a result of policyholder actions and unhedged asset risk Source: IFRS as at HY10 NWPSF 4

5 Shareholder exposure to CoG risks Risks now borne by shareholders require active management RIEESA COG RIEESA COG Assets Asset share Assets Asset share Before equity fall After equity fall Traditionally, the estate and CoG were invested in the same way as assets backing asset share Without hedging, the exposure to CoG risks would reduce the value of the RIEESA on asset fall This would restrict new business capacity and make the level of expected IFRS operating earnings more volatile So we manage the CoG risks by dynamically hedging the CoG 5

6 Dynamic hedging strategy Strategy for matching changes in CoG s and assets Impact of dynamic hedge from market fall Impact of dynamic hedge from market rise CoG Hedge pay off CoG CoG Hedge pay off CoG Hedge pay off Hedge pay off Before fall After fall Before rise After rise The hedge covers equity, property and credit but not equity volatility The hedge operates such that: When asset shares fall in value and the CoG increases there is an equal and opposite positive payoff from the hedge When asset shares rise in value and the CoG decreases there is an equal and opposite negative payoff from the hedge The RIEESA is therefore stable and earnings from it and the CoG are predictable An example is given in the appendix 6

7 Dynamic hedging strategy Continually monitored and recalibrated as required 12.5 bn Hedge Effectiveness in Target return assets Actual return assets Mar Apr May Jun Jul Aug Sept Oct The dynamic hedge is monitored daily to ensure it continues to provide the appropriate level of protection The hedge is adjusted if the asset holdings fall outside of the 250bps tolerance (it is 97.5% effective) It is fully recalibrated at every month end Profits/losses due to non-daily adjustments are minimal (profit over period of 21 million on 13 billion of return assets) 7

8 Key risk exposures Dynamic hedge significantly reduces market risk NWPSF (inc. RIEESA) Major Risks (1 in 200) % reduction Equity Property Credit Interest rates Equity Demographic Total Volatility diversified Equity, property, credit and interest risks reduced through de-risking and dynamic hedge Equity volatility remains - this is monitored closely to assess whether hedging is necessary but we expect this to mean revert over time Demographic risks of longevity and persistency are monitored/managed Low interest environment not significant due to duration matching and regular re-balancing 8

9 With-profits summary Active management of risks in a post-reattribution world creates significant shareholder opportunity for predictable IFRS earnings Reattribution has changed the shareholders risk/reward profile Aviva s dynamic hedge strategy has reduced market risks Ensuring the RIEESA can be used to write new non-profit business (expect to write 650 million over 5 years in the RIEESA) Enabling profits from the existing back book to be used for paying dividends Provides recurring, predictable IFRS operating earnings of c. 120 million p.a. and further upside/downside potential from policyholder actions and un-hedged assets 9

10 UK annuity business Large annuity back book and significant new business growth potential bn Annual liability cashflow Annuity Liability cashflow Number of people of people aged 65 aged billion annuity book with 750k customers Growth in annuity book of 5 billion over the last 3 years Growth is as a result of: Competitive pricing, supported by: Asset sourcing Longevity expertise Pricing strategies High retention of maturing pensions business (c.70%) Strong brand in the at retirement market Market growth expected to continue due to number of people reaching retirement age 10

11 UK annuity risks UK annuity business generates stable IFRS operating earnings UKA Profit Drivers m (20) (40) (60) New business margin Spread margin Expected return Acquisition expenses Admin expenses H109 H209 H110 UKA generates stable IFRS operating profits with minimal non-operating variances Profits mainly arise up-front as new business margin, with on-going profits from spread margin and expected return on excess assets, offset by expenses The growth in new business margin (and acquisition costs) reflects our competitive advantage achieved through our asset and pricing strategy 11

12 Risk management strategies Our annuity risk management strategy concentrates on credit, longevity and interest rate risk bn UKA economic capital* (1 in 200 level) Credit Longevity Interest Property Deflation Expense Other In writing annuity business shareholders are exposed to risks from: Interest and inflation Longevity Credit defaults and spreads Credit risk is the single largest risk exposure this is managed via high quality asset selection Longevity risk is managed based on appetite Interest t and inflation risks are mitigated t through h duration matching * Economic capital is based on internal assessment and capital management policies. It does not imply capital required by regulators or other third parties 12

13 Duration matching Interest and inflation risks managed through duration matching m UKA Matching asset backing FSA pillar 1 reserves Asset duration 9.6 years Liability duration 9.6 years Asset cashflows (net of expected losses) FSA pillar 1 liability cashflows Assets backing FSA Pillar 1 reserves and solvency capital are kept duration matched via asset mix and swap overlays Excess assets above solvency capital are held in interest rate insensitive assets This investment approach leaves the fund exposed to a stand alone stress of interest rate rises on a Pillar 2 ICA basis as the liability duration becomes 9.5 years But this does not lead to a significant increase in capital due to the interaction of this risk with the longevity risk in the fund 13

14 Asset strategy Unique ability to source diverse and high quality assets Access to commercial mortgages and equity release through internal companies creates pricing and profit advantages High quality corporate bond portfolio Our asset sourcing strategy provides good diversification benefits which are recognised in an economic capital world Economic Capital benefits allow more competitive pricing and superior returns for shareholders 14

15 Corporate bonds 7 billion Corporate bond portfolio of consistent asset quality Share of corporate bond portfolio 60% 50% 40% FY08 30% FY09 20% HY10 10% 0% AAA AA A BBB Portfolio stable at A rating Defaults and impairments over the last 3 years amount to 25 million on the 7 billion portfolio (equating to11bps p.a.) Compared with our long term default assumption of 31bps and additional short term provision of 24bps (overall reserve of c. 0.5 billion) There is no impact on IFRS operating profits but, IFRS total t profits benefit as experience is positive 15

16 Commercial mortgage portfolio 10 billion mortgage portfolio in UKA is high quality and has an excellent performance track record bn Total UKA Portfolio HY10 The portfolio comprises commercial property loans and NHS Healthcare & PFI loans c.50% of the book is backed by investment grade tenants including the Government 2 0 Commercial property Healthcare & PFI The NHS Healthcare & PFI loans are quasi Government so are low risk Primarily a long term fixed rate book designed to match long term fixed rate liabilities UKA NHS Healthcare & PFI Prudent underwriting philosophy involving: First legal charge over properties GPF 0.9bn Lift & PFI 0.4bn PI 1.3bn Direct lending to GPs for surgeries Lending to fund primary healthcare premises. Lending to investment companies to fund surgeries with GPs as tenants. No high risk lending such as: interest only loans with high LTVs, or mezzanine, quasi-equity or speculative development finance BSF 0.1bn Building Schools for the Future 16

17 Commercial property finance portfolio Risks in the UKA CPF portfolio are well contained through high levels of diversification 3% 2% 1% 30% 20% Top 30 Tenants Rental Exposure as % of the Portfolio Tenant Lease Rental Expiry (% of Annual Rental Value) 30% 60% 50% 40% 30% 20% 10% 0% 14% Sector Diversity UKA - CPF IPD Industry Benchmark 15% 26% 35% 9% 4% Industrial Office Other Retail Geographical Diversity 40% UKA - CPF IPD Industry Benchmark (April 2009) Well diversified portfolio by - Property sector and geography Tenant (c.4,700) Borrower (c.600) 51% 46% Diverse tenant base with only 8 exposures paying >1% of total portfolio rent The portfolio is underweight in the most volatile property sectors Average remaining lease term is 12 years which supports the long-term nature of the loans c.60% of the portfolio benefits from cross-charging 10% 0% 10.2 % < 1 Year 10.5 % 13.7 % 25.1 % 1-3 Years Years % % 4.6 % 3.2% 3.1% 1.0% Years Years Years Years Years Years Years >35 20% 10% 0% 18 % 36 % London 8% 5% 15 % 11 % East Midlands South Anglia 29 % % % 15 % 6% 6% 3% 2% North Scotland Wales Ireland 17

18 Commercial property finance portfolio Short term maturities are low and have exit LTVs significantly below the portfolio average 2,000 UKA CPF Portfolio Maturity Profile 120% Maturity Capital ( m) 1,750 1,500 1,250 1, % 80% 60% 750 LTV 40% 1, Maturity capital 20% % Average LTV across the portfolio is 98% Loans with shorter terms have lower LTVs on average Loan covenants, when available, mean we can step in and take action to secure our interests c.30% of the capital outstanding amortises over the life of the loans 18

19 Commercial property finance portfolio Realised and expected losses over the 3 year period to mid 2010 equate to c.25bps p.a. Realised and Expected Losses on Impaired Loans 30 m mid 2010 The realised and expected losses over the last 3 years are c.25bps p.a. compared with our long term assumption of 50bps and additional short term provision of 55bps (overall reserve of c. 0.7 billion) Interest service cover ratios remain resilient at 1.30x and loan service cover at 1.16x Arrears are only 1.7% of annual interest receivable and 7 day collection ratios remain strong at 99% Impairment of the portfolio is significantly lower than the industry average (3.3% for the portfolio versus an estimated 9.5% for the total industry - Source: De Montfort University survey) 19

20 summary Active management of risks creates stable IFRS earnings and capital benefits Large back book and growing new business franchise written on attractive terms (IRR 15+%) Managed from an ALM perspective to ensure shareholders have minimal interest rate risk High quality and diversified credit portfolio Generating stable IFRS earnings and a resilient balance sheet 20

21 ALM in UK Life Summary Asset and Liability management is at the core of what we do This combined with the quality of our credit portfolio Gives confidence in the resilience of our Balance Sheet, total IFRS earnings and OCG capabilities 21

22 Appendix 22

23 Dynamic Hedging Strategy Working through a simple example COG 20 Asset share Cash 50 Cash 10 Cash 40 Equities Hedge allocation (20) 100 Equities Equities Net 20 COG 22 Asset share 91 Actual assets held Cash 50 Equities 63 10% equity fall Hedge allocation Assets allocated to Asset share Cash 10 Equities 81 Assets allocated to CoG Cash 40 Equities (18) Net 22 Equities backing CoG moved opposite to market Actual assets held Assets allocated to Asset share Assets allocated to CoG 23