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Klaus Miller
Member of the Executive Board
1
Market Consistent Embedded Value is...
MCEV
(Market Consistent Embedded Value)
SNW VIF
(Shareholder Net Worth) + (Value in Force)
- CoRNHR1)
Required
Free Surplus Present Value
+ Capital
(FS) of Future
(RC) - FCoRC2)
Profits (PVFP)
- FOGs3)
1) Cost of Residual Non Hedgeable Risks
2) Frictional Costs of Required Capital
3) Financial Options and Garantees
2
Analysis of Change (AoC)
Using the example of Hannover Life Re
Opening Adjustments 204.4 1. 3. Hereunder, we show the deviations from expected economic
result of the reporting year as well as the impact of changes
Change in currency exchange rates 197.3
in economic assumptions for the future
Other implications 7.1 - Experience variances on investment return due to
unrealised gains/losses only (mainly market value of
Adjusted Opening MCEV 2,270.6
assets)
Total MCEV Earnings 448.8 2. - Experience variances on investment return
(expected vs. actual investment returns)
Operating MCEV Earnings 289.6 3.
- Economic assumption changes (e.g. impact of
Economic variances 159.2 changes in interest rates on VIF)
- Experience variances on tax and inflation
MCEV before Closing Adjustments 2,719.5
4. Movement items that are not part of total MCEV earnings
Closing Adjustments (151.2) 4.
Capital injection / reduction (109.9) 5. According to the MCEV Principles the return has to refer to
the Adjusted Opening MCEV. As in the past Closing
Dividend payments (41.3) Adjustments are eliminated.
Closing MCEV 2,568.3
3
Operating MCEV Earnings
Using the example of Hannover Life Re
4
New Business Value
Using the example of Hannover Life Re
2009 2010
in m. EUR
Profit/Loss on new business during year (295.1) (127.4)
5
Sensitivities of the MCEV (economic assumptions)*
Using the example of Hannover Life Re
in m. EUR Total
* Base run without liquidity premium. The impact of the sensitivity 'liquidity premium +10 bps'
is immaterial (< 1% of MCEV) and therefore not shown
6
Sensitivities of the MCEV (non-economic assumptions)
Using the example of Hannover Life Re
in m. EUR Total
7
Embedded Value Not Recognised
Using the example of Hannover Life Re
in m. EUR
2.400
625.2
289.9
1.600 721.0
822.3
2,568.3
2,066.2
800
1,222.1
953.9
0
2009 2010
Embedded Value IFRS Equity* Bridge financing EVNR
* After elimination of surplus notes
8
Appendix
Glossary
I
Formulae and abbreviations
SNW SNW = FS + RC
VNB VNB = P/L (NB) + PVNB - CoRNHR (NB) - FCoRC (NB) - FOGs (NB)
Return on
(MCEV before Closing Adjustments - Adjusted Opening MCEV)/Adjusted Opening MCEV
MCEV
* The capital charge for residual non hedgeable risk, so-called Cost of Capital Factor, was set to 4.5 % on a percentile of 99.95 % on internal risk capital. This
decision was made according to the CFO CoRNHR Working Group recommendation to use some value within the range of 2.5% - 4.5% for the Cost of Capital
Factor.
II
Present Value of Future Profit (PVFP)
PVFP CF1
The present value of future shareholder cash
(1 s1 )1 CF2 flows projected to emerge from the assets
(1 s2 ) 2 backing liabilities of the in-force covered
CFn
business
(1 sn )n
n
CFi
PVFP
i 1 (1 s i ) i
where
CFi = Cash Flow of year i:
Premiums
Claims
Change in Reserve
Loss during the year e.g. due to the Fees
Investment Results
acquisition costs (is included in the
Free Surplus) si = risk free spot rate
n = Projection horizon (e.g. 40 years)
1 2 3 4 5 6 7 8 9 10 11 12 13
Cashflow PVFP
III
Cost of Residual Non Hedgeable Risks (CoRNHR)
Non hedgeable risks are risks that cannot be hedged using instruments available in
financial markets. It includes non-financial risks typically included in the risk based capital
such as
mortality
longevity
morbidity
disability
pandemic
lapse
expense and
operational risks.
It also includes some financial risks, if there are no instruments available with which to
hedge those risks (e.g. default and credit risk).
IV
Frictional Cost of Required Capital (FCoRC)
Examples
From the capital market's view From the reinsurance market's view
Company distributes 100 of required capital to Company cannot distribute 100 of required
shareholder capital to shareholder
Investor invests 100 directly Investor invests 100 indirectly through the
company
Risk free return 5% Risk free return 5%
Corporate tax 25%: 1.25
Investment management expenses incurred by
company 0.1%: 0.10
Company pays dividend of net return to
shareholder: 3.65
Income before personal tax and own investment Income before personal tax and own
management expenses: investment management expenses:
5 3.65
FCoRC of 1.35 for one year= risk free x (1-tax rate) + expenses
V
Most common Financial Options and Guarantees (FOGs)
Guarantees Options
Minimum crediting rates guarantee in the Lapse option
universal life policies and deferred annuities
Policyholder can exercise the lapse option at any
with fixed interest options time
Secondary guarantees in the variable Implementation of the dynamic policyholder
annuities and variable universal life policies behavior
such as Release of hidden reserves might be required
(e.g. in case of Guaranteed Minimum Withdrawal
Guaranteed Minimum Death Benefits
Benefit Contracts (GMWBs))
(GMDBs)
Lump-sum option
Guaranteed Minimum Income Benefits
(GMIBs) Lump-sum vs. annuity payments option at the
end of the premium period
Guaranteed Minimum Accumulation
Release of hidden reserves might be required
Benefits (GMABs)
VI
Evolution from EV via EEV towards MCEV (cont'd)
Development of the Embedded Value
EV EEV MCEV
until May 2004 May 2004 - June 2008 June 2008 - October 2009
CFO Principles CFO Principles
Implicit allowance for FOGs Explicite FOGs calculation Market consistent FOGs
FOGs within discount rate (real-world capital market calculation (risk free capital
scenarios) market scenarios)
VII
Evolution from EV via EEV towards MCEV (cont'd)
Development of the Embedded Value
MCEV MCEV
June 2008 - October 2009 October 2009 CFO Principles update,
CFO Principles compulsory from 2011
Maximum of Maximum of
Local statutory minimum solvency Local statutory minimum solvency
Required capital
capital
capital Capital to achieve the target rating Capital to achieve the target rating
Capital to achieve internal Capital to achieve internal
management objective management objective
MCEV: In October 2009, the CFO Forum published an amendment to the Market Consistent Embedded Value (MCEV) Principles to reflect
the inclusion of a liquidity premium. The CFO Forum recognises that the existence of a liquidity premium is clear, as evidenced by a wide
range of academic papers and institutions. It also recognises that its inclusion and quantification are equally important for Solvency II. The
changes affirm that the reference rate to be applied under MCEV should include both the swap yield curve appropriate to the currency of the
cash flows, and on top of it, a liquidity premium, where appropriate. (Source: CFO Forum)
VIII