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CS-18: Risk Metrics

CS-18: Risk Metrics. Fred Tavan, FSA FCIA Assistant Vice President, Canada Life ERM Symposium, Washington DC July 29, 2003. Introduction. Various uses of EV Definition Methodology Pro’s & Con’s Example Application. Various Uses of EV. Information to Analysts

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CS-18: Risk Metrics

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  1. CS-18: Risk Metrics Fred Tavan, FSA FCIA Assistant Vice President, Canada Life ERM Symposium, Washington DC July 29, 2003

  2. Introduction • Various uses of EV • Definition • Methodology • Pro’s & Con’s • Example • Application

  3. Various Uses of EV • Information to Analysts • Identification of BU’s that add/destroy value • Value added by new business during year • Risk exposures to value

  4. EV Definition EV = Shareholder’s Free Surplus + Required Capital + Value of Inforce Business - Cost of Capital

  5. Shareholder’s Free Surplus • Excess of S/H’s equity over required capital • S/H’s equity is after-tax MV of assets supporting surplus

  6. Required Capital • Level of statutory capital that must be maintained before any distribution to S/H’s • Can be affected by: • regulation • ratings considerations, or • marketing purposes

  7. Value of In Force Business • Discounted value of after tax distributable profits • Profits calculated with reference only to assets supporting current liabilities

  8. Cost of Capital • Opportunity cost associated with holding required capital • Difference between assumed future investment earnings rate on surplus and the EV discount rate

  9. EV Components • Adjusted Net Worth • Value of In Force Business • Does not measure value of Future Business

  10. Methodology • 3 General Approaches • Full Financial Projections • Aggregate Projections • Approximations Techniques • Projection techniques that project future events using either aggregate or seriatim models • Claims ratio techniques acceptable in some cases

  11. Value of In Force • Full financial projections involve following steps: • setting assumptions about future experience • projecting future assets and liabilities’ cf’s • projecting required capital levels • determining future annual distributable profits • calculating pv of distributable profits

  12. Discount Rate • Risk-free rate • Risk premium addition • Should be consistent with parameters of economic model

  13. Pro’s • Consistent with finance practice of valuing free cash flows • Consistent with methods used to price new products • Commonly used in evaluating mergers and acquisitions

  14. Pro’s (con’td) • Provides useful platform for risk analysis using sensitivity and stress tests and potentially stochastic analysis • Gaining acceptance as a public reporting tool in Europe and Canada • As a by-product, can provide useful forecasts of cash flows, earnings, etc.

  15. Con’s • Modeling intensive • Sensitive to choice of assumptions • Complicated to explain to non-actuarial audience • Generally not consistent with risk neutral valuation of financial products and capital markets instruments.

  16. Example

  17. Application • Sensitivity Tests for : • currency • stock market levels • interest rate spreads • Room for creativity in generating various sensitivity tests and scenarios

  18. Stochastic Modeling • Possible for companies with few products operating in a single country • Very challenging for multi-national companies with a wide variety of products • models would take very long to run • potential solution may be distributed computing

  19. SOA Website • Detailed paper can be found at: • http://www.soa.org/sections/rmtf/embedded_value.pdf

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