What would be the ideal embedded value

reporting basis in Asia?

19th Asian Actuarial conference
Presented by
Clement Bonnet
Consulting Actuary - Milliman

Contents
Overview
Definitions and practices
Impact of EV reporting bases on the business

Overview

Overview
Asian Embedded value results

Source: Milliman 2014 Embedded results - Asia

4

Overview
How did we get here?
Why MCEV?

European
Embedded Value
(EEV)
Traditional
Embedded Value
(TEV)

Introduced in May
2004 by the CFO
Forum

Market
consistent
Embedded
Value

Increase in
transparency for
investors

Improve
consistency of
information
reported

A shareholders
perspective on
value

A market consistent
approach to
financial risk

(MCEV)

Introduced in June
2008 by the CFO
Forum(*)

ABI Guidance 2001

Achieved Profits
Method
MCEV Principles copyright Stichting CFO Forum Foundation 2008

Overview
A trend toward MCEV reporting globally?
In accordance with VIGs goal of continually improving the GEV reporting, the methodology
has changed to a Market Consistent Embedded Value (MCEV) for the first time.
Vienna Insurance Group Supplementary information on the Group Embedded Value Results

MCEV

12

(MC)EEV

12

13
Vienna
Insuranc
e Group

14
14
Generali

Achmea

12

11

15

11

MCEV principles can be

seen as the natural
development of EEV
principles. They increase
companies ability to take
into account risks and
improve the consistency
and transparency of
calculating and reporting
embedded value.
Achmea embedded value
report 2012

EEV

2010

2011

2012

2013

Source: 2011, 2012 and 2013 Milliman EV publication based on a sample of 27 companies
6

Overview
A dominating TEV framework in Asia ?
Group Domicile
Asian MNC
European MNC
North American MNC
China
Hong Kong
India
South Korea
Taiwan
Thailand
Total

TEV
2
1
6
1
1
4
6
2
23

EEV
4
1
5

IEV
2
2

MCEV
3
1
4

Total
2
7
1
6
1
5
4
6
2
34

Source: Milliman 2014 Embedded results - Asia

Asian MNCs and domestic insurers outside of India tend to report on a TEV basis,
while European and Japanese insurers favour EEV or MCEV reporting.
Apart from European MNCs and Japanese insurers, the only insurers operating in
Asia reporting EEV, IEV, or MCEV are Indian insurers. However, none of the Indian
insurers reporting EEV/IEV/MCEV currently presents externally reviewed EV results
to the extent specified in the disclosure requirements of the EEV, IEV, or MCEV
principles.
7

Overview
A dominating TEV framework in Asia ?
Some of the key multinational companies in the region
EV Reporting basis
TEV
EEV
TEV
TEV

China

MCEV

India

Hong
Kong
Thailand Philippines

EEV / MCEV

TEV/IEV(*)

TEV

Indonesia
Singapore

EEV / MCEV
(*) IEV: Indian Embedded Value

Definitions and practices

Definitions and practices

Overview ?
Alphabet Soup: The world of embedded value
reporting

Embedded value
reporting generates
a mixed response
from equity
analysts. This might
have something to
do with the
terminology

VIF

10

Definitions and practices

Components of embedded value
Time value of
options and
guarantees
(TVOG)

Present
value of
future
profits
(PVFP)

Required
capital
Free
surplus

Cost of
capital
Expense
overrun

Value of
in force
(VIF)

Adjusted
net
worth
(ANW)

11

Definitions and practices

MCEV components
Free surplus
Principle 4: The free surplus is the market value of any
assets allocated to, but not required to support, the in-force
covered business at the valuation date

Required capital
Principle 5: Required capital is the market value of any
assets, attributed to the covered business over and above
that required to back liabilities for covered business, whose
distribution to shareholders is restricted

Value of in-force (VIF)

Source: Allianz website, MCEV principles

Principle 6: The value of in-force covered business (VIF)

consists of the following components:
Present value of future profits (where profits are post
taxation shareholder cash flows from the in-force covered
business and the assets backing the associated liabilities)
Time value of financial options and guarantees as defined in
Principle 7
Frictional costs of required capital as defined in Principle 8
Cost of residual non hedgeable risks as defined in Principle
9.

12

Definitions and practices

MCEV components
Distributable earnings
approach
(+) Free surplus
(+) Required capital
(+) VIF [PVFP (TVOG +
CRNHR) Frictional costs]

Illustration
(+) Free surplus

(+) Required capital

(+) VIF

(=) MCEV

(+) Market value of assets

Economic balance sheet
approach
(+) Market value of assets

(-) Market value of liabilities

(-) Frictional costs

100
90
1

(-) Market (consistent) value

of liabilities
(-) Frictional costs

13

Definitions and practices

Comparison of TEV, EEV and MCEV
TEV
PVFP
Projection of future profits using
real-world investment return
assumptions, discounted using
subjective risk discount rate.

TVOG
Cost of
capital
(CoC)

Sometimes calculated but no

standardised requirement.

Typical practice is to explicitly

model the cost in the cash flow
projections and present it as an
adjustment to the EV figure.

EEV
Projection of future profits using
real-world investment return
assumptions, discounted using
a curve based on risk-free
rates, adjusted using a risk
margin which reflects any risks
not allowed for elsewhere in the
valuation.
Mandatory calculation using
stochastic models for material
guarantees.
Mandatory, calculated as the
difference between required
capital held at calculation date
and the present value of the
projected releases of the
required capital, allowing for
future investment return on that
capital.
Disclosed as part of required
capital.

MCEV
Projection of future profits using
market-consistent risk-neutral
investment return assumptions,
discounted using a curve based
on risk-free rates.
Discount rates can be adjusted
to include an illiquidity premium.
Consistent with PVFP
methodology, market-consistent
risk-neutral calculation using
stochastic models.

Mandatory split into Frictional

CoC and CRNHR.

14

Definitions and practices

Comparison of TEV, EEV and MCEV
TEV
Discount
rate

Subjective assumption, typically

calculated as risk-free rate plus
a margin or portfolio investment
return plus a margin.

EEV

MCEV

Two possible approaches: top

down or Bottom up

A bottom-up approach is
mandatary, and the curve is
typically on swap rates with
adjustments for illiquidity and
risk margin.

A risk-neutral approach is
typically used, where assets are
assumed to earn returns based
on a risk-free curve.

A single discount rate is typical,

using a curve is rare.

Investme
nt return

Typical practice is to use a riskfree plus risk premium approach

for main asset classes, where
the risk-premium assumptions
differ by asset class.

Can be set as per internal

assumptions.

Expenses

No standardisation, but typically

based on historical experience
and expected ongoing
experience.

Future expenses such as

renewal and maintenance
expenses must reflect expected
ongoing operating expenses.

Where expense overruns exist,

insurers will typically provide
both pre- and post-overrun
EV/VNB figures.

Expense overruns must be

allowed for.

Some insurers opt to use a riskneutral approach, while others

use a risk-free plus risk
premium approach.

Similar to EEV principles, with

additional guidance.

15

Definitions and practices

Focus on risk discount rate EEV / MCEV
Basis for risk
discount rate

Liquidity premium

Source: Milliman EV Publication 2013 Embedded Value Results Generating Value

Extrapolation

16

Definitions and practices

Focus on risk discount rate EEV / MCEV
Basis for risk
discount rate

Liquidity premium

Extrapolation

Expected
cost of
defaults
of the
issuer

Risk due to
the un
expected
cost of
defaults Other risks
linked to
the
illiquidity
of the
asset

Source: Milliman EV Publication 2013 Embedded Value Results Generating Value

Liquidity premium
17

Definitions and practices

Focus on risk discount rate EEV / MCEV
Basis for risk
discount rate

Liquidity premium

Extrapolation

Model fits
input prices
Extrapolation
towards Ultimate
Forward Rate
(UFR)

Many companies have

adopted an extrapolation
approach consistent with the
approach used in Solvency II.
Source: Milliman EV Publication 2013 Embedded Value Results
Generating Value

18

Definitions and practices

Financial options and guarantees EEV / MCEV

Financial
options and
guarantees

Stochastic
techniques

Economic
assumptions
internally
consistent
and in line
with market

Asymmetry in the impact of the range of scenarios on the

distributable earnings to shareholders.
Example of a participating contract: profits are shared between
shareholders and policyholders while losses are only shared up to a
certain point, after which shareholders bear all the subsequent
losses.

Companies are required to assess the TVOG using stochastic

techniques such as the development of a stochastic actuarial
model taking into account interactions between asset and liability.
Closed-form solutions can also be used where these lead to
sufficiently accurate results

Stochastic models must be appropriately calibrated with the

existing market information and must be internally consistent with
the rest of the modelling methodologies and approaches.
Management actions can be reflected but have to take into
account the market reaction to discretion
19

Definitions and practices

Financial options and guarantees EEV / MCEV
Illustration

Stochastic valuation

Participating product
based on an asset
share process

Deterministic valuation

(2 stochastic scenarios)
IR

Investment
return (IR)

2.5%

2.5%

Stochastic
actuarial
model

Dividend
payout

Dividend
payout

Projection year t=2

Scen1

Scen2

100

100

Benefits (except DVD) (-)

70

70

Benefits (except DVD) (-)

70

Dividend payout (DVD) (-)

10

Dividend payout (DVD) (-)

Exp and comm (-)

20

20

Investment income (+)

20

Profit

20

14

Premiums (+)

Asymmetry in the
impact on the
distributable
earnings

Mean

Projection year t=2

Premiums (+)

17

Deterministic
100

Exp and comm (-)

20

Investment income (+)

12

Profit

20
20

Definitions and practices

Expenses
MCEV Principles:
G11.7: Future expense such as renewal and other maintenance expenses should reflect the ongoing expense
levels require to manage the in-force business, including investment in system required to support that business
and allowing for future inflation
G11.8: Favourable changes in unit costs such as productivity gains should not normally be included beyond
what has been achieved by the end of the reporting period. In certain circumstances such as start-up operation,
it may be appropriate to assume that unit costs will reach their expected long-term levels within a defined period.
For clarity, the additional expenses before the long term level should be included in the VIF. ()
G11.9: The nature and impact on shareholder value of any exceptional development and one-off costs excluded
from the unit cost base should be separately disclosed.

Source: Lifenet European Embedded Value for the first-half year ended September 20,2012

21

Definitions and practices

Expenses

Source: Lifenet European Embedded Value for the first-half year ended September 20,2012

22

Impact of EV reporting bases

on the business

23

Impact on profitability
The EEV / MCEV spectrum in Asia

EEV

Long term traditional business

still part of the business mix

In-betweeners

MCEV

Mainly Investment linked and

protection

24

Impact on profitability
Illustration Universal life sold in Singapore
Illustration

Projected profits before tax

60000
50000
40000
TEV basis

MCEV Basis

30000
20000
10000
0
1

9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34

-10000
-20000

TEV Basis

MCEV basis

Underwriting
profit at outset
due surrender
value being less
than account
value

Profits constant for 5 years. Profits drop to zero in year 6 as

surrender value unwinds at same rate as profit coming
through. Negative profits in years 12 16 as surrender values
unwind faster than profits coming through. Investment spread
= 50bp throughout
Profits negative or very low up to year 7 due to low investment
returns and minimum crediting rates. Profits shoot up in years
7- 11 as previous losses are recuperated. Years 12-16 profits
decrease as surrender values unwind. Investment spread
variable throughout. See over for details

Stability where
interest rates and
crediting rates are
similar between the
products

25

Impact on profitability
Illustration Universal life sold in Singapore
Illustration
TEV Results

MCEV / TEV Results

In USD

MCEV Results

PVFP (Before COC)

97,634

TVFOG
Cost of Capital
Cost of non-hedgeable risk

RDR @ 5.75%

RDR @ 6.75%

RDR @ 7.75%

93,092

86,150

(21,469)

N.A

N.A

N.A

N.A

(34,552)

(42,560)

(48,052)

(51,451)

81,089

N.A

N.A

N.A

VNB

24,714

58,541

43,590

33,037

VNB Margin (% APE)

44.9%

106.4%

79.3%

60.1%

After Capital requirements @ 220%

IRR

20.4%

Payback period

3 years

5.0%
4.5%

Yield Curves

4.0%

3.5%
3.0%
2.5%
2.0%
1.5%

1.0%
0.5%
0.0%
1

2
3
4
5
6
7
MCEV - Interest Rate
TEV - Investment Return

10

11

12

13 14 15 16 17 18 19
MCEV - 10 year forward rate
TEV - Crediting Rate

20

21

22

23 24 25 26 27 28
MCEV - Crediting Rate

29

30

26

Impact on business
Moving to MCEV

2006, Zurich has been reporting on a (MC)EEV basis:

Source: Company website

The adoption of MCEEV made Zurich strategically focus on lines of businesses

which are market-consistent friendly (i.e. products with low guarantees)
27

Impact on business
Moving to MCEV

Source: Company website

28

Ideal EV reporting in Asia?

TEV vs EEV vs MCEV

The primary advantage that EEV and MCEV have over TEV is the greater
standardisation of assumptions, methodologies, and disclosures, leading to better
comparability from an investors viewpoint.
However, the same standardisation can lead to a relative loss of EV being a
reflection of managements viewpoint of future potential, e.g., future investment
returns assumptions in MCEV reporting.
Insurers reporting on an EEV or MCEV basis will typically experience greater
volatility in EV results, especially if a market-consistent basis is used. This can
complicate reporting and investor disclosures and is one of the reasons often cited
by industry insiders as to why some companies have not yet moved from TEV to
EEV or MCEV.
Another key reason put forward is the increased capabilities required to
implement EEV or MCEV. For example, the implementation of TVOG calculations
requires the use of stochastic models to value embedded policy options and
guarantees.
29

Thank you!
Q&A session

Disclaimer
This presentation is intended solely for educational purposes and
presents information of a general nature. It is not intended to
guide or determine any specific individual situation and persons
should consult qualified professionals before taking specific
actions. Neither the presenters, nor the presenters employer,
shall have any responsibility or liability to any person or entity
with respect to damages alleged to have been caused directly or
indirectly by the content of this presentation.

Contact information

Clement Bonnet
Consulting Actuary
+852 2152 3287 ( office )
+852 9867 0776 ( mobile)
Email: clement.bonnet@milliman.com