The Realpolitik of Using
MCEV in Asia
A Potential Way Forward for Embedded
Value Reporting in Chinese Taipei and
Elsewhere in the Region
Simon Walpole
&
Ophelia Au Young
Session Number: TBR3
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The Realpolitik of Using MCEV in Asia
Agenda
1.
Quick definition of TEV, EEV and MCEV
2.
Why is it difficult for Chinese Taipei to move to EEV or MCEV?
3.
A potential way forward for EV reporting in Chinese Taipei
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The Realpolitik of Using MCEV in Asia
1. Quick definition of TEV, EEV and MCEV
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The Realpolitik of Using MCEV in Asia
TEV versus EEV
Cost of Options
& Guarantees
Cost of
“Lock-in”
PVFP
PVFP
Traditional EV
NAV
“Lockin”
EEV
NAV
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The Realpolitik of Using MCEV in Asia
Cost of Options
& Guarantees
Cost of Financial
Options & Guarantees
Cost of Residual Non
Hedgeable Risks
PVFP
PVFP
“Lockin”
Frictional Costs of
Required Capital
VIF
EEV
NAV
MCEV
Free
Surplus
NAV
Required
Capital
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The Realpolitik of Using MCEV in Asia
2. Why is it difficult for Chinese Taipei to
move to EEV or MCEV?
6
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The Realpolitik of Using MCEV in Asia
Example 4 – WP Endowment
Comments
Recent History of Interest Rates in Chinese Taipei
Source: TII data
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The Realpolitik of Using MCEV in Asia
Negative Interest Spread
Average Guaranteed Rate of Interest
Premium Income Basis (NOT reserve basis!)
7.50%
7.00%
6.50%
6.00%
5.50%
5.00%
4.50%
4.00%
3.50%
3.00%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Estimated required yield on the Legacy block
Source: TII data and knowledge of the level of interest rate guarantees in each year
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
6.9%
6.7%
Shin
Kong
Life
6.0%
5.9%
Cathay Taiwan China
Life
Life
Life
5.7%
ING
5.5%
5.2%
PCA Life Fubon
Source: TII Data and JP Morgan estimates
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The Realpolitik of Using MCEV in Asia
Liability & Asset Duration Mismatch
About Age 25
Source: Deloitte’s projection using a sample Chinese Taipei life company
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The Realpolitik of Using MCEV in Asia
Guaranteed Health Products
% of First Year Premium Income (Y1) in Health Products
35%
30%
25%
20%
15%
10%
5%
0%
Source: TII Data
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The Realpolitik of Using MCEV in Asia
Profits: Experience over 10 Years from 1994
10.0%
50.00%
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
8.0%
6.0%
4.0%
2.0%
0.0%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Earned Rate
1994
Guaranteed Rate
1997
2000
Initial Expenses as % of FYP
0.0180000
2003
Renewal Expenses as % of RP
35.00%
0.0160000
90% of
89TSO
0.0140000
1993
30.00%
25.00%
0.0120000
1994
0.0100000
1996
20.00%
15.00%
0.0080000
0.0060000
1997
1999
10.00%
0.0040000
5.00%
2002
0.0020000
2000
60
58
56
54
52
50
48
46
44
42
40
38
36
34
32
30
-
0.00%
Y1
Y2
Y3
Y5
Y10
Source for all charts: Deloitte’s presentation at 5th CEO Summit
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The Realpolitik of Using MCEV in Asia
Profitability: Sensitivity
Impact on VIF before CoC
6% Investment Return
5% Investment Return
4% Investment Return
-150.0%
-100.0%
-50.0%
4% Investment Return
0.0%
50.0%
100.0%
150.0%
Impact on VIF after CoC
300% RBC
300% RBC
250% RBC
250% RBC
20% Tax
-200.0%
-150.0%
-100.0%
Source: Deloitte’s study using a sample Chinese Taipei life insurance company
-50.0%
0.0%
50.0%
Source: Deloitte’s study using a sample Chinese Taipei life insurance company
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The Realpolitik of Using MCEV in Asia
Profitability: Sensitivity
Impact on VIF before CoC
Expense
+ 10%
- 10%
Lapse
+ 10%
- 10%
Mortality and Morbidity
+ 10%
- 10%
RDR
+ 100 bps
-15.0%
-10.0%
- 100 bps
-5.0%
0.0%
5.0%
10.0%
15.0%
Source: Deloitte’s study using a sample Chinese Taipei life insurance company
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The Realpolitik of Using MCEV in Asia
Summary of Recently Published EV Results
As at 31.12.2010
Cathay
Shin Kong
Published Results (NT$BN)
ANW
VIF before CoC
CoC
VIF
EV
VNB
Method & Assumptions
Method
Fubon
China Life
TW Life
193.00
338.00
-82.00
256.00
449.00
43.00
148.50
62.30
-34.80
27.50
176.00
12.60
81.90
114.50
-40.90
73.60
155.50
24.80
48.10
36.00
-12.96
23.04
71.14
6.88
12.134
21.159
-6.119
15.04
27.18
4.27
TEV
TEV
TEV
TEV
TEV
10%
10.00%
11.00%
10.50%
10.00%
RDR (VIF)
RDR (VNB)
Source: company’s published EV disclosure
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The Realpolitik of Using MCEV in Asia
Recent Transaction Prices
•EEV/MCEV is lower relative toFubon/ING
TEV due to the Aegon/Meifu
explicit allowance NanShan
for the time/
value of options and guarantees
Ruentex
Published
Results
(NT$BN)
•We have
assumed
that MCEV produces a higher TVFOG than EEV
Announcement
DateTVFOG = 20 for Oct-08
Feb-11
•At point of sale,
EEV and TVFOG =Apr-09
40 for MCEV
Transaction
19.50
64.80
•AssumeValue
uniform “run-off” of TVFOG
over duration 2.73
of policy
Stated
Book
Value
27.33 on:
4.65
148.04
•The
extent
of the reduction will depend
Price/Book
0.59x
0.43x
– Value
The size of the free estate –0.71x
if large free estate then
lower shareholder
cost
Metlife /
Chinatrust
Oct-11
5.30
9.80
0.55x
– Management
Source: internet information
decision rules in respect of bonuses and policyholder behaviour in
respect of lapses in different scenarios and asset dynamic asset mixes
Different approaches
used for EEV
and MCEV
Assume that–Transaction
Value and assumptions
= Appraisal
Value
= Embedded Value + Value of Future New Business
Assume that Value of Future New Business > 0
So
Transaction Value
> Embedded Value
> Book Value + VIF
But
Transaction Values
< Book Value
Means
VIF
<0
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The Realpolitik of Using MCEV in Asia
3. A potential way forward for EV
reporting in Chinese Taipei
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The Realpolitik of Using MCEV in Asia
Issues with TEV in Chinese Taipei – Methodology
• Investment return assumptions
• Objectivity difficult to demonstrate
• Risk margins capitalised (riskier assets => higher EV)
• Allowance for risk
• Cost of options and guarantees not fully recognised
• Same RDR for all product types
• Cost of capital limited to 200% RBC
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The Realpolitik of Using MCEV in Asia
Issues with TEV in Chinese Taipei – Credibility
• EVs more optimistic than implied EV in actual life company transactions
• Many transactions
• Implied VIF negative in every case
• VIF in published EV positive in every case
• Are transacted companies different from those with published EVs?
• EVs higher than market capitalisation in some cases
• Observed over several years in some cases
• But market cap is for whole listed Group, not just the life insurance entity…
• Other studies suggest that EEV or MCEV would be lower
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The Realpolitik of Using MCEV in Asia
Issues with TEV in Chinese Taipei – International Benchmarking
• TEV has disappeared in some places:
• Europe, where EV was invented
• South Africa
• It seems to be disappearing from some places in Asia:
• Japan
• It is still widely used in some places:
• China – but there the reasons for holding back from EEV or MCEV do not (in
general) include concern over the result
• Australia – but there is evidence that the result would not be much different
EEV or MCEV
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The Realpolitik of Using MCEV in Asia
Issues with TEV in Chinese Taipei – Local Benchmarking
• IFRS4 Phase 2
• Government has stated a desire to “align with international reporting
standards”
• Impact study being carried out now
• Solvency capital
• Government has stated a desire to “align with international reporting
standards”
• AA cash flow testing now stochastic, being enhanced every year
• EV
• No changes
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The Realpolitik of Using MCEV in Asia
Issues with TEV in Chinese Taipei – Objectivity
• Written standards
• CFO Forum standards only started with EEV
• No local standards
• Reliance on independent sign-off – but independent reviewers desire
objective standards too
• Disclosures
• Current public disclosures vary widely
• CFO Forum disclosures very comprehensive
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The Realpolitik of Using MCEV in Asia
Issues with TEV in Chinese Taipei – Other
• Practicality
• Stochastic methods now standard in Chinese Taipei
• Understandability
• Some complaints about MCEV
• Not so many about EEV
• Are analysts & investors really asking for this?
• They don’t talk about it much
• Market cap situation => EV adjustments are downwards
• High awareness of implied VIF figures in transactions
• Overseas analysts & investors do ask overseas companies
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The Realpolitik of Using MCEV in Asia
Options: Overview
Methodology
Status Quo
TEV
Progress
EEV
International Best Practice
MCEV
Progress
Local Guidance
International Best Practice
CFO Forum-style
Progress
Investigate then judge
International Best Practice
Do it ASAP
Written Standards & Disclosures
Status Quo
None / Elementary
Timing
Status Quo
Wait until someone asks
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The Realpolitik of Using MCEV in Asia
Methodology: Keep the Status Quo
Methodology
Status Quo
TEV
Progress
EEV
International Best Practice
MCEV
• There is a credibility risk in keeping the status quo
• Results not consistent with market observables
• Objectivity of assumptions can be challenged
• Benchmarking internationally becoming more difficult
• Benchmarking locally becoming more difficult
• Reliance on independent sign-off could become restricted
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The Realpolitik of Using MCEV in Asia
Methodology: Going to MCEV
Methodology
Status Quo
TEV
Progress
EEV
International Best Practice
MCEV
• Results would be much more dependent on non-controllable risk
• Without a high “liquidity premium”, the VIF would be very negative
• Even with a high “liquidity premium”, the VIF will be very volatile
• In the short term, unlikely to be much pressure to move to full MCEV
• Full MCEV is still evolving anyway
• Pressure to improve on TEV is not immediate, so there is time to move
to MCEV later if necessary
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The Realpolitik of Using MCEV in Asia
Methodology: Something in Between
Methodology
Status Quo
TEV
Progress
EEV
International Best Practice
MCEV
• Only viable medium-term option
• Helpful flexibility within EEV approaches
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The Realpolitik of Using MCEV in Asia
Written Standards & Disclosures
Status Quo
None / Elementary
Progress
Local Guidance
International Best Practice
CFO Forum-style
• There are various risks in
keeping the status quo
• Little disclosure could
lead to questioning of
credibility (IFRS4 will
have more?)
• Pressure from
regulator
• Pressure from
independent reviewers
• Benchmarking
internationally shows
differences
• Standards should be
developed locally, with
reference to
international best
practice (eg IFRS4, RBC)
• Requires a working
group to draft, then
energy to discuss and
agree
• This is a good longer-term
aspiration
• Standards should match
chosen method; if EEV, can
refer to first draft CFO
Forum principles
• Factual disclosures should
follow best practice
• Disclosures around results
require understanding, and
understanding can require
time
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The Realpolitik of Using MCEV in Asia
Timing
Status Quo
Wait until someone asks
Progress
Investigate then judge
International Best Practice
Do it ASAP
• It is not clear when EEV will be demanded, but…
• …sooner or later China will move to EEV or MCEV
• At the latest when they start buying European entities
• The impact on their EV will be less than on Chinese Taipei EVs, so they can
implement more quickly
• In Chinese Taipei:
• Question of moving to EEV (or MCEV) is “when” not “if”
• Implementation date = earlier of:
• Demand from regulator, analysts or independent reviewers
• When companies are confident about the results
• Investigation start date = as soon as possible
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The Realpolitik of Using MCEV in Asia
Our Proposal for Chinese Taipei
Methodology
Progress
EEV
International Best Practice
MCEV
Progress
Local Guidance
International Best Practice
CFO Forum-style
Progress
Investigate then judge
International Best Practice
Do it ASAP
Status Quo
TEV
Written Standards & Disclosures
Status Quo
None / Elementary
Timing
Status Quo
Wait until someone asks
Working Group should start as soon as possible
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The Realpolitik of Using MCEV in Asia
Our Proposal for Chinese Taipei – Methodology
• EEV following the original CFO Forum principles
• Top-down RDR is fine: RDR = risk-free + 2.5% (?)
• “Direct” approach but only for main portfolios
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The Realpolitik of Using MCEV in Asia
Our Proposal for Chinese Taipei – Methodology: EEV
Cash Flows
• Deterministic
approach for
products with
no
guarantees
• Stochastic
approach for
TVFOG of
products with
embedded
future
options &
guarantees
European EV
(“EEV”)
Economic
Assmpns
European
EV (“EEV”)
Non-Econ
Assmpns
Deterministic
Deterministic
• Same as
TEV
• Usually as per
TEV
Stochastic
Stochastic
• Dynamic
lapse and
take up
assumpns
allow for
p/holder
behaviour for
products with
gtees
• Simulations
based on
real world
assumpns
• Must be
internally
consistent
but not
necessary
market
consistent
• May also
allow for
dynamic
mangment
behaviour
European EV
(“EEV”)
TVOG
• Stochastic
valuation of
time value of
options &
guarantees
captures:
– Mangmt
behaviour
– P/holder
behaviour
– Cost of
s/holder
capital
injections
• Assumptions
used not
necessarily
market
consistent
European EV
(“EEV”)
Discounting
• Similar to
TEV, constant
RDR set equal
to risk free
rate plus a
risk margin
• One
exception is
that the risk
margin no
longer
contains an
allowance for
the cost of
options &
guarantees,
as there is an
explicit
allowance for
those in the
calculation
European
(“EEV”)
Cost of
Capital
• Required
capital needs
to consider
both
– Amount
required
by
regulators,
and
– Amount
required
by internal
measures
• Cost of lock-in
defined as
per TEV
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The Realpolitik of Using MCEV in Asia
Our Proposal for Chinese Taipei – Investment Return & Capital
• Investment return assumptions
• Use the stochastic cash flow testing assumptions
• Brings in objectivity, easier disclosure
• Live with the fact that risk margins are capitalised (riskier assets =>
higher EV)
• This was part of the original EEV approaches, so can be explained as
part of “Chinese Taipei’s transition”
• Allowance for risk
• Continue to use 200% RBC
• Objective, easier disclosure
• Only consistent with CFO Forum disclosures if companies state that
“amount required by internal measures” = 200% RBC
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The Realpolitik of Using MCEV in Asia
Potential Impact on Results
Product
Move from TEV to EEV
Compulsory Dividend
Traditional Non Par
Traditional True Par
Interest Sensitive Annuities
Universal Life
Unit Linked
Variable Annuities
?
Riders
TOTAL VIF
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The Realpolitik of Using MCEV in Asia
Practical Approach
1.
Set up an EV Working Group (two streams: methodology & disclosures)
on an industry-only basis (but with reviewers)
2.
Start with the original CFO Forum EEV methodology, on a top-down,
partially-indirect basis
3.
Use the stochastic cash-flow testing assumptions and RDR = risk-free +
2.5%, and investigate the results
4.
Understand the results, focus on drivers and main influencers on the
results – go bottom-up, fully direct?
5.
Finalise a medium-term approach with transition plan (over n years,
where n is 3+)
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The Realpolitik of Using MCEV in Asia
Elsewhere in Asia
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The Realpolitik of Using MCEV in Asia
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