European Embedded Value, first year application Alberto Minali March 10th, 2005

European Embedded Value, first year

application

Alberto Minali

March 10th, 2005

Introduction Group

A newly established set of principles for EV calculations provides a better valuation of all risk components, in particular of embedded options

Ras is one of the first international companies and the first Italian company to publish EEV in compliance with CFO forum principles

Values and methodology have been certified by Tillinghast-Towers Perrin

The 2003 discount rate has been recalculated for comparative purposes only; 2003 results have not been restated

1

Agenda Italy

Methodology and main results

Portfolios characteristics

Cost of options

Financial risk margin

Non-Financial Risk Margin

Conclusions

2

Ras

choice

Ras

choice

The alternatives

Top-down discount rate based on WACC or CAPM methodology, with one single risk premium and cost of options deducted from total In-force value

Bottom-up discount rate based on valuation of risk factors, with differentiated risk premiums by Line of business and country

Practice widely used by competitors, with risks partially captured in the discount rate and partially in projected inflows. Overlapping of stochastic and deterministic frameworks

Discount rate not diversified by product, highly subjective (top-down risk premium) and based on market information (beta)

Discount rate tailored to the specific risk factors of different products and different companies, with bottom-up valuation of risk premiums. Important impact on risk management

Consistent link between stochastic and deterministic frameworks

3

Further details on methodology Group

Risk premium is obtained as the sum of different risk components on top of the risk-free rate. Ras has identified and measured the following ones:

• Margin for embedded options: the time value of the put option cost sold to policyholders (calculated in a stochastic environment) is expressed as basis points of risk premium

• Margin for financial risk: neutralises the equity component assumed in projected investment returns. Linked to equity exposure and equity risk premium

• Non-financial risks: associated with lapses, mortality, longevity and business risks, calculated using the Ras Risk Capital Model

The risk premium obtained is company-specific, business-specific, valuation-dependent. Ras calculates a different discount rate for Traditional Life, unit linked and Asset management business in Italy

4

Traditional products discount rate Risk free equivalent to 10 year bond yield - data in %

Italy

20042003

6.61

Remarks

Risk free

Financial Risk margin 0.89

4.50

1.15Non-financial risks

6.30

0.79

3.75

1.41

Decrease of overall discount rate arises from the risk free rate reduction of 75 bp

Stable financial risk margin is consistent with unchanged equity exposure and risk premium

Strong increase in time value component of put options is due to the term structure shift

Higher non-financial risk premium driven by an increase of lapses risk

Changein bp

-31

+26

0.15Time Value of options

0.35 +20

-10

-75

5

Unit Linked discount rate Italy

20042003

6.75

Risk free

Financial Risk margin

0.47

4.50


6.55

0.77

3.75

2.03

Changein bp

-20

+25

+30

-75

Remarks

75 bp decrease in risk free rate is partially compensated by the increase of other risk factors

Higher financial risk margin is linked to the higher average equity exposure

Higher non-financial risk premium driven by lapses risk

Risk free equivalent to 10 year bond yield - data in %

6

Asset Management discount rate Italy

20042003

7.30

Risk free


1.35

4.50


7.00

1.60

3.75

1.65

Changein bp

-30

+20

+25

-75

Remarks

75 bp decrease in risk free rate is partially compensated by the increase in other risk factors

Higher financial risk margin is linked to the higher average portfolio duration and equity risk premium

Higher non-financial risk premium driven by volumes and higher capital absorption

Risk free equivalent to 10 year bond yield - data in %

7

Preliminary conclusion Group

The new methodology enables:

• to measure the immediate impact of different ALM strategies on the risk profile of our business and therefore on the EV

• to assess the impact of different technical product features (e.g., redemption or penalty fees) on the discount rate and therefore on pricing

With this new methodology in place Ras can now enhance both risk and value mgmt

2003 old

2003 new

2004 new

2.50% 2.11% 2.55%

Unit Linked

Traditional

2.50% 2.25% 2.80%

Asset Mgmt

2.50% 2.80% 3.25%

8

Agenda Italy



Cost of options



Conclusions

9

Ras portfolios Group

Traditional products: the tight Asset-Liability strategy reflects Ras long-term expertise in AL techniques, with very limited A-L cash flow mismatch and low equity exposure

Unit-linked: very conservative equity exposure of high volatility periods; in 2004 Ras took advantage of better financial market conditions to slightly increase investment risk profile

Asset Management: a good balance of equity and bond exposure, almost unchanged during 2004, due to the still cautious approach of clients to financial mkts

10

Traditional portfolio ItalyRas Vitariv - starting year 2005 - equity exposure 6%, corporate bond 19.2%, 2004 recorded return 5.02% of which 4.96% ordinary

yearsYie

ld

Assets

Liability

2005 2015

4.7%

5.0%

2.9%

3.4%

Asset and Liability cash flow

1 2 3 4 5 6 7 8 9 10

Cash flow Mismatch

2005 2015years

990 1,250750 500

-800 -850 -600 -700

+190 +400+150

-200

Projected financial returns and avg. min. guaranteed

11

Unit linked and Asset Management Italy

2003 2004

Unit Linked

2003 2004

Asset Management

Equity

Balanced funds

Bond and liquidity

26%

74%

24%

76%

43%43%

7%7%

50%50%

12

Agenda Italy



Cost of options



Conclusions

13

Further details on methodology Group

The stochastic model projects portfolio financial returns in a neutral risk probability environment

The model is calibrated on the interest rate structure at valuation date and on implied market volatility

Projected financial returns consider: existing assets; management options to steer financial returns; accounting rules

Cost of options is very limited due to tight ALM and conservative equity exposure

Financial returns are still higher than minimum guaranteed rates

Cost of options increased in 2004 due to lower interest rates; this offsets the positive effect of new products with non-cliquet options

14

0.15

Time Value component of cost of option Total Italian portfolio

Italy

20042003

Risk free


Time Value of options

Non-financial risks

0.35In % of traditional Reserves

Absolute valuemln euro

16.8

36.3

20042003

0.29

0.16

Total Cost of time valueTotal group in Italy Ras-Vitariv

5.4

16.8

20042003

0.27

0.11

0.17Ras Vitariv 0.37

15

Projected Financial scenarios and returns

Financial returns of segregated funds are determined considering the accounting rules and management rule

Accounting rules: financial returns credited to policyholders are not marked to market but based on accruals + dividends + realised capital gains

Management rule: the possibility for management to steer financial returns and to reduce their volatility

Financial returns of segregated funds generated by stochastic model

years

Financi

al re

turn

s

Best estimate

Scenarios

16

Price of the put option

The stochastic model runs 5,000 scenarios and therefore 5,000 financial returns are generated

For each financial return below the minimum guaranteed rate, the model calculates losses incurred by the shareholder

The net present value of these losses, weighted for the probability of the individual scenario, determines the cost of the put option

The put option has two components. Intrinsic value and Time value

Cost of option years

Financi

al re

turn

s

Minimum guarateed rate layers

Scenarios

years

NPV weighted

for probability

17

Put option breakdown in intrinsic and time value

years

Financi

al re

turn

s

Minimum guarateed rate

Scenarios

years

Best estimate

Put value Intrinsic value Time value

Mln euro 107.3 71.0 36.3- =

2004 data

Ras Vitariv 47.0 30.2 16.8

years

Already captured into the deterministic EV

18

Impact of accounting rule and mgmt option

Put option

Time value

Margin for Embedded options

With accounting and Mgmt rules

years

Financi

al re

turn

s

years

Financi

al re

turn

s

Marked to mkt

Base Value

Mk to Mkt

47.0

16.8

0.37%

2004 data - Ras Vitariv

207.2

71.3

1.67%

Put option

Time value

Margin for Embedded options

19

2004 data - Rasvitariv

Sensitivity

Time value of option sensitivity

Base premium

Increase of Equity exposure

at 10%

Italy

Bond Duration at 4 years

Equity at 10% and bond duration at 4

years

50 bp decrease of interest rate

Absolute valuemln euro

16.8

21.2

38.8

43.2

24.1

Increase of equity volatility at 20%

0.46%

0.37%

0.85%

0.96%

0.55%

0.41% 19.5

Base case assumptions

5.9%

6 years

10y bond 3.75%

10%

(1)

(1) Increase of 50 bp interest rate reduces time value risk margin to 0.23% 20

Agenda Italy



Cost of options



Conclusions

21

Financial risk margin: summary Italy

Stochastic EV works in a risk-neutral framework, without any extra return for equity or other non-bond asset classes

Deterministic EV takes into account equity risk premiums and the equity exposure of the company (deterministic assumptions)

In a non-arbitrage framework, deterministic assumptions of extra returns must be compensated by an increased discount rate

The old EV methodology achieved this compensation by adding a comprehensive risk premium (2.5%) to the risk-free

The new methodology calculates the risk premium in accordance with the specific characteristics of the company portfolio

22

ItalyFinancial risk margin: main data

2003 2004

Traditional products

Mln euro - Individual business only

2003 2004

Unit linked

2003 2004

Asset Management

Equity risk premium

Equity exposure

Financial risk premium 0.82% 0.79% 0.47% 0.77% 1.35% 1.60%

2.5% 3.0% 2.5% 3.0% 2.5% 3.0%

6.0% 5.9% 26%24% 43% 43%

23

Financial risk margin: methodology

The stochastic model determines average financial return in a risk- neutral environment (projecting portfolio returns utilising risk-free rates and discounting at risk-free rate)

The Stochastic mean EV is equal to the deterministic Certainty Equivalent EV (projecting mean financial return and discounting at risk-free rate)

Best estimate EV-risk

neutral equal to CE

EV

Pro

babili

ty

Portfolio financial returns

Stochastic EV

years

Financi

al re

turn

s

Sto

chast

ic E

V

mean

mean

24

Portfolio financial returns

The bridge from stochastic to deterministic

In deterministic EV, the financial return stream of the stochastic model is adjusted to take equity risk premium into account

The financial risk margin is the risk premium that neutralises the extra return introduced in the deterministic EV due to equity exposure

EV with equity risk premium, discounted at risk free

Best estimate EV-risk

neutral = CE

Financial risk

margin

EV

EV

Pro

babilt

y

Stochastic EV

yearsFi

nanci

al re

turn

s

years

Financi

al re

turn

s

Equity risk premium

Sto

chast

ic E

VD

ete

rmin

isti

c EV

mean

mean

25

2004 data - Ras Vitariv

0.91%

0.79%


Financial risk margin sensitivity

Total Base premium

Increase of Equity exposure

by 5%

Italy

Increase of Equity risk premium by

50 bp0.73%

0.90%

0.77%

Unit linked

0.95%

0.71%Vitariv Base

premium

6% Tradit.29% Unit L.

3.00%

Base case assumptions

26

Agenda Italy



Cost of options



Conclusions

27

Non-financial risks margin: summary Italy

The non-financial risk margin captures all risk factors of a non-financial nature

Since all expected potential losses are already factored in the deterministic assumptions (e.g. lapses curve), there is the need to measure unexpected losses

The framework used by Ras to model unexpected losses is the Risk Capital Model, which it has been using since 2001

The cost of capital needed to cover unexpected losses can be considered a correct pricing for these risks

28

ItalyNon-Financial risks margin: main data

2003 2004


Mln euro - Individual business only

2003 2004

Unit linked

2003 2004

Asset Management

Total risk capital

RC as % of reserves or assets

Mortality lapses business

Non-financial risk margin

Of which in %

1.63% 1.41% 1.78% 2.03% 1.45% 1.65%

1.6% 2.5% 1.1% 1.1% 1.06% 1.14%

32 21

78 137 69 88

20 3048 49

12 177612 16

67

79 160

73 6927 31

29

• The lapses curve used in the deterministic EV is shocked by company/portfolio specific factors (Worst Case EV)

• The RC is determined as the difference between Best Estimate EV and Worst Case EV

• The cost of holding this capital is deducted from the earnings stream to calculate the CE EV-CoC

• The non-financial risk premium makes the new EV equal to the CE EV

Risk capital for lapses

EV

Pro

babili

tyNon-Financial risks margin: lapses example

years

Lapse

s

Determisitic EV

Assumptions

x 2

Worst case

Best estimate EV = CE

Worst case

Non financial margin

EV

Best estimate EV = CE

CE - Cost of Risk capital

Risk capital stochastic model

Best estimate

30

Agenda Italy



Cost of options



Conclusions

31

Final remarks Group

Ras figures data are based on a stochastic model developed with the assistance of ALEF. Tillinghast has provided an independent opinion on and review of the EEV and discount rate decomposition

To compare Ras results with competitors, Tillinghast measured also a CAPM-like discount rate, which is equal to 6.50%, based on 0.9 Beta and 3.00% Risk Premium

The new system further enhances our existing risk management capabilities, which has been an historical competitive advantage. Now we can even better manage what has been measured

32

Certain of the statements contained herein may be statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. In addition to statements which are forward-looking by reason of context, the words “may, will, should, expects, plans, intends, anticipates, believes, estimates, predicts, potential, or continue” and similar expressions identify forward-looking statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (i) general economic conditions, including in particular economic conditions in RAS Spa’s core business and core markets, (ii) performance of financial markets, including emerging markets, (iii) the frequency and severity of insured loss events, (iv) mortality and morbidity levels and trends, (v) persistency levels, (vi) interest rate levels, (vii) currency exchange rates including the Euro - U.S. dollar exchange rate, (viii) changing levels of competition, (ix) changes in law and regulations, including monetary convergence and the European Monetary Union, (x) changing in the policies of central banks and/or global basis.The matters discussed in this release may also involve risks and uncertainties described from time to time in Allianz’s filings with the U.S. Securities and Exchange Commission Allianz assumes no obligation to update any forward-looking information contained in this release.

Cautionary Note Regarding Forward-Looking Statements

33

Documents

European Embedded Value, first year application Alberto Minali March 10th, 2005