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The Younger Members Convention Fair value

abcd. The Younger Members Convention Fair value. 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire. Agenda. A brief update on International Accounting Standards (IAS) Key issues and questions Examples Annuity Unit-linked With-profits . A brief update. Phase 1

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The Younger Members Convention Fair value

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  1. abcd The Younger Members ConventionFair value 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire

  2. Agenda • A brief update on International Accounting Standards (IAS) • Key issues and questions • Examples • Annuity • Unit-linked • With-profits

  3. A brief update Phase 1 • To be implemented by 2005 • Settles definition of insurance contracts • Allows current local GAAP for contracts within definition but with additional disclosure • Review of existing standards (IAS 39) for contracts outside definition Phase 2 • Full IAS to be implemented by 2007

  4. Summary of EU Position Liabilities Assets IAS 39 applies in all cases Is it an insurance contract? Yes Pre 2007 Yes Post 2007 No IAS 39 Insurance IAS Local GAAP

  5. Agenda • A brief update • Key issues and questions • Examples • Annuity • Unit-linked • With-profits

  6. What are the issues? • Can we implement IAS? • Will our business even be classified as insurance? • Will stochastic projections be required? • How do results compare with existing methods?

  7. Key questions and concerns • What is the impact on day 1? • How volatile are profits likely to be? • Is the communication of results likely to cause problems? • How will analysts interpret the results? • What will be the impact on our share price?

  8. Agenda • A brief update • Key issues and questions • Examples • Annuity • Unit-linked • With-profits

  9. Methodology & principles: A brief re-cap • Asset/liability approach • Prospective discounted cash flow approach • Best estimate market consistent assumptions • Allowance for non-market risk • Entity specific value • Stochastic vs deterministic

  10. Annuity • Pension annuity • Single life, male age 75 • Level annuity £2,500 p.a. • Tax rate 30% • Corporate bonds, duration matched • Corporate yield curve, 5.5% flat • Government yield curve, 5.0% flat

  11. Annuity - sensitivities • 0.5% downward shift in yields • Yield curve steepening • 0.5% increase in credit spreads

  12. Results - Annuity

  13. Results - Annuity

  14. Results - Annuity

  15. Annuity - Conclusions • Day 1 fair value liability will be greater than embedded value liability • Fair value profit sensitive to cash flow matching • Fair value profit sensitive to change in credit spreads • Different results obtained for different product classes (e.g. term assurance)

  16. Agenda • A brief update • Key issues and questions • Examples • Annuity • Unit-linked • With-profits

  17. Unit linked savings • Unit-linked savings • Male age 40 • Term 30 years • Annual management charge of 1% p.a. • Monthly premium £100 • Initial fund size £5,000

  18. UL Savings - sensitivities • Surrenders increased by 25% • Fall in equity values of 25% • Expenses increased by 50%

  19. Results - UL Savings

  20. Unit linked - Conclusions • Day 1 fair value liability will be similar to embedded value liability • Volatility of profits similar under fair value and embedded value • …..unless smoothing currently applied in EV • Other issues • Are these insurance contracts? • What allowance should be made for future renewals?

  21. Agenda • A brief update • Key issues and questions • Examples • Annuity • Unit-linked • With-profits

  22. Unitised with profit (UWP) bond • Male age 55 • Single premium £15,000 • 1% annual management charge • Annual and terminal bonuses • Market value adjustments (MVA) apply • MVA free date on 10th anniversary

  23. With profits - Key issues • Prevalence of guarantees • Requirement to do stochastic runs • Need to model management discretion

  24. UWP Bond - sensitivities • A fall in equity values of 25% • An increase in implied volatility of 5%

  25. UWP Bond - sensitivity results

  26. UWP Bond - sensitivity results

  27. UWP Bond - further sensitivities • Dynamic reversionary bonus (RB) rule • Dynamic asset allocation • Reduced equity backing ratio (EBR) • Static surrender rates

  28. UWP Bond - sensitivity results

  29. UWP - Conclusions • Day 1 impact will depend upon cost of guarantees • Future volatility will depend upon: • Matching of assets • Management discretion • Policyholders reasonable expectations

  30. Wider implications • Regulatory impact? • The death of embedded values? • Better understanding and quantification of risks

  31. Summary • Day 1 impact will be significant but will vary from product to product • Results/profit will be more volatile

  32. Comments/questions …

  33. abcd The Younger Members ConventionFair value 2-3 December 2002 The De Vere Daresbury Park Hotel, Warrington, Cheshire

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