Margin on ServicesKey features and components of MoScompared to US GAAP and the UKAchieved Profits

Margin on Services (MoS) is the financial reporting methodology for lifeinsurance businesses of Australian companies.

It applies to all Australian life companies and to Australian companies withlife insurance subsidiaries.

Agenda

• Life accounting regimes compared• Emergence of profit• Components of profit

Approaches to Life Insurance Accounting

UK MSSB

IAS

Primary accounts for AMP(AMP is listed in Australia)

• Introduced in 1995• Basis for all statutory reporting

• Introduced in the 1980’s• Defined by accounting standards and other

guidance

• Based on embedded value calculations(or accruals method)

• Used for supplementary reporting and forsome group consolidated accounts

• Based on solvency calculation, modified toremove some distortions

• Official basis for UK insurers

• Draft Statement of Principals issued in 2002• Likely to be comparable to Achieved Profits

Method, but with important differences

Margin on Services(ie: Australian GAAP)

UK Achieved Profit

US GAAP

Three approaches for comparison

Other accounting standards not addressed here

Relevant to US Analysts

Relevant to UK Analysts

Not as helpful to Market asachieved profits

Still under development

The Modified Statutory Solvency Basis (MSSB) is the official basis ofreporting in the UK. Being solvency based it is not considered as helpful tothe market as the Achieved Profits method.

International Accounting Standards are still in development.

Approaches contrasted here:

MoS (Australian GAAP)• Realistic basis of accounting

• Based on deferral and matching of revenue and expense - profits emerge over thelife of the business as services are provided

• Consistent method for all lines of business

• Primary accounting method in Australia

US GAAP• Variety of methods depending on line of business

• Well established in US market although arguably in need of updating

UK Achieved Profits (AP)• Not prescribed by regulators, but accepted industry practice

• Used for supplementary reporting and consolidation in some group accounts

• Accepted practice becoming better codified with updated guidance from theAssociation of British Insurers’ (ABI)

Comparison of Standards -Valuation of Investment Assets

Choice of methods: book value,

amortised to maturity, marketvalue

Market Value

Market Value

MoS

US GAAP

UK AP

• MoS & AP use a market relatedliability valuation, giving aconsistent overall position

• Categorising assets as “trading”under US GAAP (hence marketvalued) can lead to profit volatilitywhere liabilities are passivelyvalued

Under MoS and AP, asset volatility doesn’t necessarily produce profitvolatility (except for assets backing retained profits and capital).

Under US GAAP, profit volatility may occur where assets and liabilities arenot consistently valued.

Comparison of Standards -Valuation of Insurance Liabilities

Combination of methods.

Broadly designed to give steadyemergence of profit with someprudence

Designed to give a steadyemergence of profit over life of

policies

Reflects market value of in force

contracts

MoS

US GAAP

UK AP

• MoS & US GAAP have a similar“deferral and matching” aim

• AP is more driven by thebalance sheet

• AP Profits can be volatile

Comparison of Standards -Deferral of Acquisition Costs

Shown explicitly as an asset.

Less deferral allowed than MoS.Amortised in line with prescribedprofit carrier.

Implicit deferral through valuationof liabilities. Amortised in line with

planned profit.

Implicit deferral through valuation

of liabilities

MoS

US GAAP

UK AP

• All three effectively deferacquisition costs

• Only US GAAP shows DACexplicitly on balance sheet

• US GAAP is strictest on definitionof deferrable costs

• MoS more generous than USGAAP in terms of what canbe deferred

• AP goes even further in allowingfuture margins to be recognisedas profit in year of sale

Comparison of Standards -Valuation of Subsidiaries

Consolidated in the usual fashion

- i.e. valued at net asset value

Market Value if a subsidiary ofa life insurance company

Consolidated in the usual fashion

- i.e. valued at net asset value

MoS

US GAAP

UK AP

• MoS extends the concept ofmarket value of assets tosubsidiaries of a life insurer

Comparison of Standards -Enabling Legislation or Standards

FASB accounting standards 60,

91, 97 and 120

Life Act 1995. AccountingStandard 1038 and Actuarial

Standard 1.03

Generally accepted industry

methods but wide variability inpractice. ABI guidance only. Notgoverned by accountingstandards

MoS

US GAAP

UK AP

• US GAAP is the oldest and hasthe most prescriptive rules

• MoS is also well defined, butrelies more on principles

• AP has fewer rules but is nowbecoming more codified

Comparison of Standards -Other Differences

• Discounting of deferred tax provisions

• Emergence of profit net or gross of company tax

• Disclosure of premium revenue and claims expense

• Other differences which are not specific to life insurance

• Provisions for deferred tax are usually discounted to present valueunder MoS and AP, but not under US GAAP.

• Profits emerge net of company tax under MoS and AP, but gross of taxunder US GAAP.

• Disclosure of premium revenue and claim expense may differ, althoughit does not affect the amount of profit recognised.

Agenda

• Life accounting regimes compared• Emergence of profit• Components of profit

Emergence of profit

Profit rarely recognised at pointof sale. Loss recognised ifunprofitable

Usually a loss at inception asacquisition costs exceed initialfees. Further loss recognised ifproduct is unprofitable overall

Significant element of profit (orloss) at point of sale

• Total profit is the same over thelife of a contract

• Each method allows profits to berecognised over a policy’s lifetime

• Mechanism for deferral and timingof recognition differs

Differences in timing of profit recognition

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Point of sale

Year

UK Achieved Profits US GAAP MoS

The different patterns of profit after sale reflect differences in the profitcarriers used under each method:

• MoS -profit carriers are related to the service being provided.

• US GAAP - profit carriers are effectively prescribed by the standards.

• AP - planned profit emerges from the release of margins in thevaluation assumptions and/or the unwinding of the discount rate used tovalue the future cash flows.

Change in non-investment assumptionsand future experience

Immediate impact only if adversechange exceeds future profits

Some immediate impact foruniversal life business. Immediateimpact on traditional business onlyif adverse change exceeds futureprofits

Always an immediate impact onprofit

• There is little scope under MoSto alter profit by changingassumptions

Assumes actual experience change in line with assumption changes

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UK Achieved Profits US GAAP MoS

MoSUnder MoS, policy liabilities are assessed using best estimate

assumptions which must be changed as conditions change:• The effect of changes in non-investment assumptions is absorbed in

profit margins and recognised in the future

• If the change is such that future losses are anticipated then the loss must berecognised immediately. Previously recognised losses may be reversedimmediately a favourable assumption change occurs

US GAAPUnder US GAAP, the approach varies by product:

• For universal life business the effect of assumption changes on amortisationof DAC is complex, and is not totally prospective

• For traditional business, assumptions are fixed at the time of issue. Theeffect on profit of any re-assessment is similar to MoS

• A favourable assumption change does not result in immediate reversal ofpreviously recognised losses

Change in non-investment assumptionsand future experience

UK AP

• Under AP, realistic assumptions are used. They are adjusted asconditions change, although favourable changes should only be madewhen the improvement is reasonably certain.

• The effect is recognised immediately as profit or loss

Summary:While there is more scope to alter assumptions under MoS than

under US GAAP, such changes have little impact on therecognition of profit. However, the same does not apply toAchieved Profits.

Change in non-investment assumptionsand future experience

Change in investment assumptions andfuture experience for with-profits business

Impact reflected in reduction in futurebonuses

No immediate impact on traditionalbusiness as adverse change unlikelyto exceed future profits

Always an immediate impact on profit

• Profit is shared betweenpolicyholders and shareholders.The effect on shareholder profit ofchanges in assumptions is thereforesubdued

• Profit distributed to shareholdersis usually proportional to the bonusdistributed to policyholders

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UK Achieved Profits US GAAP MoS

MoS

• Adverse changes in assumptions (including, in this case, futureinvestment earnings) are absorbed by a reduction in current and futurebonuses

• The impact on shareholder profit is spread mostly into the future

• Actual investment experience on with-profits business is treated thesame way

US GAAP

• Under US GAAP, the effect is similar as the valuation margins set up atthe time of issue will usually be sufficient to absorb the effect ofsubsequent deterioration in assumptions

UK AP

• Under AP, the level of future supportable bonuses will also vary withactual investment experience and changes in future assumptions. Butthe resulting change in the value of future transfers to shareholders isrecognised immediately as profit and not spread into the future

Change in investment assumptions andfuture experience for with-profits business

• Under all three methods where actual non-investment experience differs from expected,the impact is recognised immediately asexperience profits or losses (in addition tothe expected profits).

• Net investment earnings on retained profitsand capital in a life fund are also recognisedimmediately as profit in the reporting period.

• However, the impact of actual investmentexperience on assets supporting policyliabilities depends on the nature of theproduct and varies between the differentmethods. Refer earlier slide on “Valuationof Investment Assets”

One-off Experience Deviation

Always impacts profit

Always impacts profit

Always impacts profit

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UK Achieved Profits US GAAP MoS

Summary - profit emergence

• MoS releases profits steadily over the life of the policy

• MoS very rarely recognises any profit at inception of the policy

• Profit under MoS can be less sensitive to assumptionchanges

• MoS profits are often less volatile on the whole

Agenda

• Life Accounting regimes compared• Emergence of profit• Components of profit

The total operating earnings underMoS consist of the componentsshown.

Note: In documents such as AMP’s Investor Report,accountability for different business units is bestreflected by normalising the investment earnings.The difference between actual and normalisedearnings is included separately in the performanceof Corporate Office.

Normally profit is not recognised at new businessinception. Instead, profit margins on new businessare held within the Policy Liabilities, to be releasedas planned profit over the future life of the business.

Operating Earnings under MoS

Normalisedinvestmentreturn onallocatedcapital

Plannedprofit

margins

Experienceprofits orlosses

Totaloperatingearnings

Change inassumptions

Note that total Group P&L earnings will include:n Investment return above/below long term raten Non-life earnings(New standards restrict the use of exceptional items)

Operating Earnings under MoS Operating Earnings in US GAAP

Note that total Group P&L earnings and US GAAP earnings will include:n Investment return above/below long term raten Non-life earnings

(For group P&L earnings new standards restrict the use of exceptional items)

n Profits arisingfrom better orworse experiencethan assumed willbe similar for bothmethods

n Changes in assumptions can affectboth, but they do not as a matter ofcourse for MoS

Normalisedinvestmentreturn onallocatedcapital

Plannedprofit

margins

Experienceprofits orlosses

Totaloperatingearnings

Forecastprofits

includingrelease ofprovisions

for adversedeviations

Change inassumptions

Totaloperatingearnings

Loss onnew

business

nComparablebase

n US GAAP defersless acquisition costthan MoS, so newsales activity candepress profits.However ongoingmargins are higher inUS GAAP

Change inassumptions

Experienceprofits orlosses

Under US GAAP:

• The operating earnings have a comparable base although thedelineation between the release of planned margins and theinvestment return on capital may not be entirely clear.

• Fewer acquisition costs are deferred, so new sales activity cangenerate a small loss. Ongoing margins are correspondingly higher.

Operating Earnings under MoS Operating Earnings inAchieved Profits

Note that total AP earnings will include:n Exceptional itemsn Investment return above/below long term raten Non-life earnings

n Profits arisingfrom better orworse experiencethan assumed willbe similar for bothmethods

n Under MoS fewer assumption changesimpact profit than under Achieved Profits,but losses are recognised

Normalisedinvestmentreturn onallocatedcapital

Plannedprofit

margins

Experienceprofits orlosses

Totaloperatingearnings

Change inassumptions

Totaloperatingearnings

Value addedby new

business

n Comparableitems, though MoSwill tend to be off alarger base

n Equivalent of profitmargins under AP isthe margin for risk,usually reflected indiscount rate

Change inassumptions

Experienceprofits orlosses

Expectedearnings onnet worth

Release ofmargin for

risk

n Value added bynew business is notrecognised in theyear of sale in MoS.It is spread throughplanned profitmargins

Note that total Group P&L earnings will include:n Investment return above/below long term raten Non-life earnings(New standards restrict the use of exceptional items)

Under AP:

• The equivalent of the planned profit margins is the margin for risk,usually reflected in the discount rate. Planned profit is released asmargins are no longer required or as the discount rate “unwinds”.

• Value added by new business is explicitly recognised in the year ofsale. Ongoing margins for risk are correspondingly lower.

• The effect of changes in assumptions is recognised as a mater ofcourse.

Summary - components of profit

• Similarities exist between components of profit under

the various methods

• Experience profits are essentially the same

• Treatment of new business under MoS is essentially“neutral”

• There is less volatility under MoS from changes inassumptions

Notice

This presentation has been prepared as a general summary only. It isnot intended to be an exhaustive statement of the various accounting

regimes. This presentation does not contain accounting advice andshould not be relied upon as such. If you require detailed advice on theaccounting treatment of a specific situation please consult Ernst & Youngor some other qualified accounting professional.

This presentation has been prepared by AMP with the assistance of international accounting firm, Ernst & Young, who confirm that itappropriately conveys the key similarities and differences of the various accounting regimes as they affect life insurance business.

Whilst every care has been taken in the preparation of this presentation, no representation or warranty is in any way given or impliedas to the accuracy or completeness of any statement or information contained in it. Neither AMP nor Ernst & Young accept anyliability or responsibility for any information or statement contained in this presentation nor for any loss or damage suffered or incurredby you or any other person arising as a result of using, disclosing or acting on any information or statement contained in thispresentation.