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Page 2
Agenda
Defining the asset (establishing a common language)
Selling the asset
Mortgaging the asset
Conclusion
Questions
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 3
Disclaimer
Solutions described have been used elsewhere in the last2 years but may not be as effective in the localmarket/regulatory environment
Some solutions may not be available locally or currently
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 4
Assumptions
Local life insurers have significant inforce business
Local regulatory requirements include a level ofconservatism, particularly on mortality and/or persistency
True in almost all jurisdictions
Serves to hide one of the companies biggest assets
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 5
Common Language
Value of Inforce (VIF)
– VIF is the discounted present value of all futurestatutory profits on a block of inforce business
– For the purposes of this presentation VIF does notinclude consumption or release of solvency orrespectability capital
– Only items which contribute to statutory profits areincluded in VIF
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 6
Common Language
Embedded Value (EV)
– EV = VIF + Free Assets
– Free Assets include all capital not included in the VIFreserves
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 7
The Hidden Asset
Almost by definition, VIF is not an admissible asset forsolvency calculations
In many regimes the VIF of inforce business is very largewhen compared to the solvency needs of the companydue to high historical margins
As a rule of thumb, mortality VIF is about 0.1% to 0.5% oftotal sum at risk
Insurers are more and more commonly looking to the VIFto finance organic growth or acquisitions
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 8
A Sample of UK Insurers UsingVIF Based Capital
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Solvency as % of Total Assets
0
0.02
0.04
0.06
0.08
0.1
0.12
CG
NU
Life
AXA
Sun
Life
Cler
ical
Med
ical
Inv.
Gro
up
Frie
nds
Prov
iden
t
Prud
entia
l
Nat
iona
l Pro
vide
nt L
ife
Lega
l & G
ener
al A
ssur
ance
Scot
tish
Equi
tabl
e
Scot
tish
Wid
ows
Brita
nnic
Roya
l & S
un A
llian
ce
Scot
tish
Prov
iden
t Ins
titut
ion
Roy
al L
ondo
n M
utua
l
Lond
on L
ife
Eagl
e St
ar L
ife
Pear
l Ass
uran
ce
Scot
tish
Mut
ual
Equi
tabl
e Li
fe
Sun
Life
Other
Fin Re or Securitisation
Sub Debt or Cont. Loan
Assets
Source:
UK Life Insurance Companies2001 Capital & SolvencyReview - Ernst & Young
Page 9
Agenda
Defining the asset (establishing a common language)
Selling the asset
Mortgaging the asset
Conclusion
Questions
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 10
Selling the Asset
Includes everything from traditional reinsurance to sale ofthe life company
Generally raises the highest proportion of VIF
Often creates rating capital (S&P only give credit for 50%VIF)
May be more acceptable to regulators
Possible difference in USGAAP treatment if deemed atrue sale
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 11
Selling the Company
What it is:
– Obvious
When to use it:
– The parent needs capital
– Life insurance (or at least this sub) is a not a corestrategy
– Maximizing the amount of capital raised is importantas sale may realize significant extra value over VIF interms of free assets and franchise value
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 12
Selling a BlockAdmin Re
What it is:
– Admin Re is a popular solution in the US for divestingan under-performing or non-core block of business
– Effectively all responsibility for running off a definedblock is passed to the reinsurer including policyadministration
– Selling to a professional reinsurer protects yourownership of clients
– Expense savings and management focus are oftenkey drivers
– Difficult to pursue in Hong Kong due to the limitedavailability of established TPAs and existing low costbase
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 13
Selling a BlockAdmin Re
When to use it:
– The insurance company needs reliable long termcapital
– Rating capital is an issue
– Legacy product or system issues take adisproportionate amount of time
– Maximizing the effective use of VIF is important as itmay release up to 100% of VIF (if discount rates arerealistic) or more depending on expense assumptions
– Can also be used to sell a whole company when costefficiency is more important than franchise valueHidden Assets
David HowellChief Pricing Actuary, Zurich
Page 14
Sale of Mortality Margins
What it is:
– Most valuation bases require conservativeassumptions to be made about mortality or similarnon-investment risks which implies that a reliablestream of future profits exist
– These future cashflows can be crystallized byreinsuring large blocks of inforce mortality risk atpremium rates just under the valuation assumption
– An initial commission payment compensates thecompany for the loss of the future cashflows
– Can be a very cost effective way of accessing VIFwithout giving up control of the block
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 15
Sale of Mortality Margins
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Base Profits
0
50
100
150
200
250
1 2 3 4 5 6 7 8 9 10
Valuation Mort Expected Mort Mort Profit
Page 16
Sale of Mortality Margins
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Profits with Block Reinsured
0
50
100
150
200
250
1 2 3 4 5 6 7 8 9 10
Valuation Mort Reinsurance PremiumCommission Mort Profit
Page 17
Sale of Mortality Margins
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Comparing Profit Patterns
0
50
100
150
200
250
1 2 3 4 5 6 7 8 9 10
Base Profit Reinsured Profit Rein Profit 2
Page 18
Sale of Mortality Margins
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Comparing Profit Patterns
0
50
100
150
200
250
1 2 3 4 5 6 7 8 9 10
Base Profit Reinsured Profit Rein Profit 2
Page 19
Sale of Mortality Margins
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Comparing Profit Patterns
0
50
100
150
200
250
1 2 3 4 5 6 7 8 9 10
Base Profit Reinsured Profit Rein Profit 2
Page 20
Sale of Mortality Margins
Isn’t this giving away profit?
– This depends on how profit is defined
– On a pure dollars/euros/pounds of cashflow basis“Yes” but the profit emerges earlier and so can beinvested
– On an EV or RoC basis this method frequentlyincreases profits as a specialist reinsurer is morecapital efficient in managing mortality risk
– How is the increase in financial stability and strategicoptions valued?
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 21
What about the credit risk?
Insurer Credit Risk
– If the initial commission is paid in cash atcommencement the reinsurer will be exposed tomaterial credit risk
– This credit risk will have an associated cost and maylimit the capital that can be raised
– Cost can be reduced and capital availability increasedby credit risk mitigants such as trusts and paymentoffsets
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 22
What about the credit risk?
Reinsurer Credit Risk
– If the initial commission is paid in cash atcommencement there is little or no reinsurance creditrisk
– If other structures are used then the choice ofreinsurer becomes even more important than thenormal structuring skills and competitiveness issues
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 23
What about policyholderpersistency risk?
Reinsurers are generally adverse to taking large amountsof policyholder persistency risk and hence it is expensiveto reinsure
This risk is affected by the day to day management andmarketing activities of the insurer
The majority of persistency risk can be structured out ofthe treaty such that it is retained by the insurer
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 24
Sale of Mortality Margins
When to use it:
– The insurance company needs reliable long termcapital
– Rating capital is an issue
– Admin efficiency is already high
– Maximizing the effective use of VIF is important as itmay release up to 100% of mortality VIF (if discountrates are realistic)
– A stable stream of future margins are desirable(achieved by setting reinsurance premiums less thanvaluation assumptions)Hidden Assets
David HowellChief Pricing Actuary, Zurich
Page 25
Sale of All Margins
Effective sale of NB is the norm for term business in theUS and UK
– Generally level premium and high initial commission
– Sale of total mortality and persistency margin on 80-90% of the business
– This is not the high premium and high profitcommission type of reinsurance more commonly donein Continental Europe and Asia
– Doesn’t fit easily with the others topics in thispresentation as it is generally applied to NB
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 26
Agenda
Defining the asset (establishing a common language)
Selling the asset
Mortgaging the asset
Conclusion
Questions
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 27
Mortgaging the Asset
In all forms this consists of taking a loan against securedagainst the VIF
Major differences lie in how the capital in loaned and whothe lender is
Rarely raises more than 50% of VIF, if that
Generally does not generate any ratings capital
Requires detailed knowledge of regulations and possiblydiscussions with regulators
Credit analysis can is very thorough and may seemintrusive
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 28
Financial Reinsurance (Fin Re)
What it is:
– Fin Re is the provision of capital via a reinsurancetreaty with minimal insurance risk transfer
– Charges are defined in terms of a percentage of thecapital supplied
– Usually backed out by ratings agencies in assessingcapital
– Broadly separated into cash and non-cash
– Availability has dropped and price increaseddramatically in the last 24 months
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 29
-20
0
20
40
60
80
100
120
Assets Liabilities
Capital Financing
Before After
Financial ReinsuranceCash with Deficit Account
Increases assets by providing areinsurance advance, or equivalentcontingent loan, which is repaid - withinterest - from future regulatory surplus
Repayment is directly contingent onfuture surplus actually emerging
So no liability to repay is established
So regulatory capital is increased by theamount of the cash payment
In summary, it borrows cash todaysecured against future profits
Increase Assets - Repayment from Surplus
Page 30
Financial ReinsuranceCashless with Virtual Capital
Reduces liabilities by providingreinsurance for no initial premium which isthen recaptured from future regulatorysurplus
Recapture is directly contingent on futuresurplus actually emerging
So no liability to recapture is established
So regulatory capital is increased by theamount of the liability reinsured
In summary, it allows excess reserves tobe released early
-20
0
20
40
60
80
100
120
Assets Liabilities
Capital Financing
Before After
Reduce Liabilities - Recapture from Surplus
Page 31
Financial Reinsurance (Fin Re)
When to use it:
– Capital need is short term and fairly predictable
– Ratings capital is not an issue
– The amount of VIF available is stable and largecompared to the capital need
– Best used by financially strong companies as thiskeeps costs and regulatory problems down
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 32
Securitisation
What it is:
– Securitisation is effectively cash based Fin Re wherethe reinsurance is supplied by the capital markets
Additional Issues:
– Credit assessment much more public
– May accept longer payback period than reinsurers
– Reinsurance wrap may make placement easier
– Only major life insurance securitisation to date is NPIin the UK
– Current markets may not respond positivelyHidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 33
Subordinated Debt
What it is:
– Issuance of highly subordinated long term (usuallyperpetual) sub debt
Issues:
– Key factor is local regulation
– Regulation changes have made this a popular optionin the UK in 1999-2001
– Current markets may restrict attractiveness
– Common intra-group structure (contingent loan)Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 34
Agenda
Defining the asset (establishing a common language)
Selling the asset
Mortgaging the asset
Conclusion
Questions
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich
Page 35
Points to Consider
Is the available VIF big enough to address your needs orat least make a material contribution to it?
Is the need just for regulatory capital or does ratingscapital need to be considered as well?
Is the capital need short term or long term?
Is the capital needed in the life company or its parent?
Is stabilizing future results be a beneficial side effect?
What solutions are available in your market?
Tax? Key driver or obstacle for many deals.
Hidden AssetsDavid HowellChief Pricing Actuary, Zurich