Managing Currency Risk: Looking Back and Focused on the Future

1. CIA Annual Meeting LOOKING BACK…focused on the future

2. Moderator • Jonathan Hede • Speakers • Jacques Boudreau • Gord Marvel

3. Considerations in Defining & Managing Currency Risk Gord Marvel Sun Life Assurance Company June 29, 2005

4. What is it • Why is this an issue • Expectations • Where is it • Is it a risk • Accounting for currency • Quantifying currency risk • A Final Word

5. What is it • Financial loss arising from changes in foreign exchange rates • Less general focus than interest rate, equity, credit risk operational risks • Should it?

6. What is it • Transactions in other than the base currency of the operation • Global vs. local presence / aspiration • Enterprise vs. territorial perspective • Investments • Liability vs. surplus • Foreign Operations • Income from primary vs. ancillary vs. discontinued operations • Balance sheet exposure to investment in foreign operations

7. Why is this an issue • Globalization • Investments • Policyholders • Suppliers • Volatility in F/X • Secular movement • Shocks & revaluations

8. Why? … Globalization • Territorial operations • Appropriate investments may not be available in required currency • Market limitations – terms, structures, credit, qualities, sectors, liquidity, currency restrictions • Policyholders • Foreign operations • Dual residencies • Vendors / Suppliers

9. Why? … Volatility

10. Why? … Volatility

11. Why? … Volatility

12. Why? … Volatility

13. Why? … Volatility

14. Why? … Volatility

15. Where - Accounting for Currency • Current Canadian GAAP: • Balance sheet: • Impact of change in F/X flows through income • IF – enterprise has self-sustaining operation(s) in a foreign currency, impact of change in F/X flows through Currency Translation Account (CTA)

16. Where - Accounting for Currency • Current Canadian GAAP: • Income: • Change in F/X is based on the average F/X rate(s) during year • Impact follows balance sheet treatment • Derivatives: • No special treatment of foreign exchange hedging • No specific Canadian GAAP guidance for derivative accounting • New Accounting Guidelines • A discussion for another day

17. Where – Income Statement • Premiums • Investment Income • Fee Income • Benefits • Expenses • Taxes • Change in Reserves

18. Where – Balance Sheet • Assets • Replication using foreign assets (including derivatives) or foreign assets as eligible asset class • Investment in foreign operations • Accounts receivable • Liabilities • Product reserves & liabilities & provisions • Accounts payable • Corporate issued debt • Equity • Currency translation

19. Expectations “In the long run we are all dead. Economists [Actuaries] set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean will be flat” With apologies to John Maynard Keynes

20. Expectations • Shareholder • Global or Local play • Policyholder • Solvency • Management • Value proposition? • Balances expectations & sets framework

21. Expectations • F/X policy principles: • Balance prudence, strategies & tactics • Holistic view with respect to preferred risks • Segmentation considerations • Degree of hedging/exposure – partial vs. complete – address speculation • Recognize organizational structure • Self sustaining territories vs. manufacturers/distributors • Local vs. enterprise accountabilities & management

22. Risk Considerations • Introduces volatility • What role does currency exposure play in the enterprise value proposition • None, or • Long term business strategy, or • Lesser of two evils • Should it be hedged away? • May not be viewed negatively - response requires consideration of expectations & point of reference

23. Risk Considerations • Which currencies should be hedged? • Materiality – where are largest exposures • Practicality – where are active & developed F/X derivative markets • Residual risk – use proxies or leave unhedged

24. Quantifying Currency Risk • Business objectives • Planning & scenario risk assessments • Capital & reserves • Pricing – internal vs. market implied • Technical issues • Key dynamics – technical vs. fundamental view • Decision statistics • Materiality & resources/capabilities

25. Quantifying Currency Risk • Balance quantification sophistication with business need & capabilities • Literature search doesn’t point to any clear preference in either fundamental or technical streams • Simple notional exposure monitoring may be good enough, or • Simple distributions or adaptations of other model structures may be good enough

26. A Final Word • Considerations in the management of currency risk extends beyond simple risk identification, quantification & mitigation • Fundamental operating principles and the value proposition for shareholders & policyholders need to be considered • Organizations should be clear on how much currency risk their key stakeholders are expecting • At a minimum, there should be sufficient testing to either dismiss F/X as an immaterial risk or to confirm the level of risk to which stakeholders will be subjected