Agenda. Questions Deloitte & Touche LLP Deloitte Advisory Sp. z o.o. Adjusted Net Asset. Value (ANAV)

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1 Agenda Embedded Calculation for Life Insurers ICTI 00 Marcin Piskorski Traditional Embedded (TEV) European Embedded (EEV) Market Consistent Embedded (MCEV) Actuarial Software - Prophet Questions 00 Deloitte & Touche LLP 00 Deloitte Advisory Sp. z o.o. A QUICK SUMMARY OF THE EMBEDDED VALUE CONCEPT Traditional Embedded COMPONENTS OF THE EMBEDDED VALUE NPV of Future Profits (NPVFP) (CoC) Embedded (EmbV) NPV of Future Profits from the existing (PV of capital charges) 00 Deloitte Advisory Sp. z o.o. 00 Deloitte Advisory Sp. z o.o. ADJUSTED NET ASSET VALUE NET PRESENT VALUE OF FUTURE PROFITS BALANCE SHEET Book value (local statutory) * Actuarial Statutory equity * actuarial Statutory equity Undisclosed surplus s Liabilities * In bonds, stocks real estate Share of hidden allocated to NPVFP 00 Deloitte Advisory Sp. z o.o. Tax P&L inforce (local statutory) + Premium + Interest income Benefits Increase act. Alloc. to participation Tax profit xxxx xxxx xxxx xxxx xxxx xxxx xxxx Expected future net profits NPVFP Discounting at rate 00 Deloitte Advisory Sp. z o.o.

2 COST OF CAPITAL Required capital for inforce (EU solvency margin) charges (Earned rate rate) x Shareholder s part of required capital charge Policyholder s part Shareholder s part n European Embedded Discounting at rate 7 00 Deloitte Advisory Sp. z o.o Deloitte Advisory Sp. z o.o. CFO Forum Membership made up 9 of the large European multi-national insurance groups Chaired by Chris Sewell of Aviva Moderated by PwC No consultants allowed in the group Condition of membership was adherence to a confidentiality code prior to publication date AEGON Allianz Aviva AXA Fortis Generali Hannover Re ING Legal & General Munich Re Old Mutual Prudential Scottish Widows Skia Stard Life Swiss Life Swiss Re Winterthur ZFS Deloitte Advisory Sp. z o.o Deloitte Advisory Sp. z o.o. CFO Forum THE EUROPEAN EMBEDDED VALUE CONCEPT Goals of the group To develop guidance on the presentation of an embedded value as supplementary financial information for European insurers To address the existing criticisms of Embedded Methodology is credible, robust capable of being consistent across geographies / companies The cost of guarantees are catered for explicitly There is sufficient disclosure with sensitivity analysis To ensure that the methodology reflects the economic value of long term insurance 00 Deloitte Advisory Sp. z o.o. NPV of Future Profits (NPVFP) (CoC) Explicit of Gtees Options (VoG) European Embedded (EEV) COMPONENTS OF THE EUROPEAN EMBEDDED VALUE NPV of Future Profits from the existing (PV of capital charges) Explicit Gtees Options 00 Deloitte Advisory Sp. z o.o.

3 What are the key challenges options guarantees How do we calculate the fourth component the time value of options guarantees? How do we set an economic basis that is consistent throughout the calculations? The benefits written in participating life insurance have an option-like pay off profile They have a floor (the guarantees provided) They have an upside (future bonus decisions) So it is appropriate to use option based techniques to value these contracts How do set the rate now that we have explicitly allowed for a large portion of the risk? If they were simple pay off structures we could use a technique like Black Scholes to achieve this How do we present the result? Unfortunately they are not we are pushed in the direction of more sophisticated techniques like stochastic valuation Using a stochastic valuation technique we can calculate a value for the options guarantees (time intrinsic value) of the written 00 Deloitte Advisory Sp. z o.o. 00 Deloitte Advisory Sp. z o.o. The This doesn t look like an Embedded We haven t cut it into its four component parts Have we taken care of all of the risks, in particular the non financial risks? Step : Step : EV based on = () () guaranteesrantees. Step : Step : EV based on = () = () () pure risk free Reduction roll up. due to use of but with an rate. of Step. Step : but with an Step : = () = () () 00 Deloitte Advisory Sp. z o.o. 00 Deloitte Advisory Sp. z o.o. Intrinsic time value of options The intrinsic value of an option is based upon the risk free yield curve In our first calculation we have time intrinsic combined Step : Step : EV based on = () () guaranteesrantees. Step : Step : EV based on = () = () () pure risk free Reduction roll up due to use of discounting but with an rate. of Step. Step : Step : = () = () () 7 00 Deloitte Advisory Sp. z o.o Deloitte Advisory Sp. z o.o.

4 One of the four pieces Now we have the time value of the options guarantees, we just do our traditional EV we are finished? Yes, but. We must choose a basis that is consistent Investment return roll up Risk discount rate So let s set the investment return assumption as we have always done Based on asset mix Yields on different asset classes Risk premiums for some assets classes (eg equities) Incorporate the run off of UNRCG from bonds Step : Step : EV based on = () () guaranteesrantees. Step : Step : EV based on = () = () () pure risk free Reduction roll up due to use of discounting but with an rate. of Step. Step : Step : = () = () () 9 00 Deloitte Advisory Sp. z o.o Deloitte Advisory Sp. z o.o. What about the Risk discount rate I have goal seeked to get a rate for my embedded value basis Does it capture all of the risks that I want? No, what about non financial risks? 00 Deloitte Advisory Sp. z o.o. Step : Step : Step : Step : Step : Step : EV based on = () () EV based on = () = () () = () = () () roll up. due to use of pure risk free Reduction options gua- but with an discount rate. guations increased risk but with an tions the one used rantees. rantees. in Step in porate a mar- order to incor- of Step. gin for other risks than those from financial options 00 Deloitte Advisory Sp. z o.o. Step : Step : Step : Step : Step : Step : EV based on = () () EV based on = () = () () = () = () () roll up. due to use of pure risk free Reduction options gua- but with an discount rate. guations increased risk but with an tions the one used rantees. rantees. in Step in porate a mar- order to incor- of Step. gin for other risks than those from financial options 00 Deloitte Advisory Sp. z o.o. Market Consistent Embedded 00 Deloitte Advisory Sp. z o.o.

5 Market consistent valuation All assets are valued at their market value Discounting cash flows rather than profits Usually risk-neutral scenarios used Dynamic calculations (management actions, policyholder behaviour) Actuarial Software - Prophet Stochastic calculations (options guarantees) 00 Deloitte Advisory Sp. z o.o. 00 Deloitte Advisory Sp. z o.o. iworks Prophet iworks Prophet Prophet - Life provides a fast, friendly flexible solution for actuaries involved in life assurance, permanent health insurance insured pension products. It manages the calculations financial models used for: Embedded appraisal valuations Cash flow financial projections premium, gross premium discounted cash flow valuations Realistic earnings valuations reporting (including achieved profits, US GAAP Margin on Services) /liability modelling Dynamic solvency testing Stochastic projections Surplus bonus strategy analyses Product pricing design Analysis of surplus movement in embedded values At the October 00 SunGard purchased Prophet system the life libraries from Deloitte The main rationale for the sale was regulatory SunGard can offer clients a significant improvement in the IT field of Prophet. Deloitte will be continuing to use Prophet in all its consultancy work will be continuing to provide implementation other services around Prophet to clients. More information Deloitte Advisory Sp. z o.o Deloitte Advisory Sp. z o.o. Questions? 9 00 Deloitte Advisory Sp. z o.o.