Reinsurance Perspective

Volatility of Fair Value Accounting

Michael Frings FSA, CFA, MAAA

Vice President and Senior Actuary

Global Financial Solutions

RGA Reinsurance Company

SOA Webcast | March 13, 2013

Sources of Fair Value Volatility Solutions to Reduce Volatility

Presentation Topics

A reinsurance perspective on ceding company fair value volatility

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Sources of Fair Value Volatility

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Assumptions Market inputs: interest rates, volatility, strike prices, etc. Company inputs: policy holder behavior, mortality, morbidity, etc.

Models Company structure Hedging activities Accounting Interpretations: Yesterday, Today & Tomorrow

US GAAP US Statutory IFRS MCEV

Reasons for Fair Value Volatility

Movement due to …

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Need to know your sources of fair value volatility

Income Statement Operating Earnings (‘Core’) vs. Non-Operating Income (‘Non-Core’) Net Income

Balance Sheet Equity / Accumulated Other Comprehensive Income (AOCI) Assets Liabilities Disclosure Only

Accounting Sources of Fair Value Volatility

With the geography of volatility, some places are better than others…

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Fair value disclosed as required

US GAAP ASC 820 (FAS 157) – Fair Value Measurement ASC 815 (FAS 133/FAS 155) – Derivatives & Hedging

Guaranteed withdrawal benefits guarantees in variable & indexed annuities Excess indexed benefits in indexed annuities Stable value wrap contracts Financial guarantees DIG B36 – funds withheld coinsurance and mod-co

ASC 320 (FAS 115) Investments – Debt & Equity Securities Designation: Trading (IS & BS effects); AFS (BS/OCI only) Other than Temporary Impairment (IS & BS effects)

ASC 944 (FAS 97/120) – Shadow DAC Asset ASC 825 (FAS 107/159) – Fair Value Disclosure ASC 250 (FAS 155) – Designating Fair Value of Liabilities

Accounting Sources of Fair Value Volatility

Selected from common accounting pronouncements…

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US Stat SAP 43R/99 – Other Than Temporary Impairments SAP 86 – Accounting for Derivative Instruments & Hedging Activities SAP 100 – Fair Value Measurements Actuarial Guidelines 35 & 43

IFRS IAS 7 – Financial Instruments: Disclosures IFRS 9 – Financial Instruments IFRS 13 – Fair Value Measurement (effective 1 Jan 2013)

MCEV Supplementary embedded value reporting for EU companies European Embedded Value (EEV) principles and European Insurance

Market Consistent Embedded Value (MCEV) principles published by CFO Forum

Accounting Sources of Fair Value Volatility

Selected from common accounting pronouncements…

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Solutions to Fair Value Volatility

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Hedge, Hedge, Hedge…is there a perfect hedge? Clearly interpret and define Fair Value

Develop fair value calculation with clear, consistent assumptions Can explain fair value movements better to management & investors

Adopt ‘book value’ rather than ‘fair value’ approaches Does this sweep financial issues under the rug? Discourage risk management?

Find Another View of the Business Another – The Another could be...

Reinsurer(s) Buyer(s)

View – Their View could be… Are in a different accounting regime Likes the risk better than you

What Can Insurers Do

Some solutions…

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Reinsure mortality/longevity risk only Cheaper like YRT on the net amount at risk Doesn’t address fair value issues

Coinsure business Straight co/mod-co structures which are akin to selling the business Funds withheld structures create US GAAP DIG B36 fair value volatility

Structure reinsurance to carve out risks Use capital markets and reinsurance solutions to carve out market,

mortality and policyholder behavior risks Difficult to find those willing to take each of the risks…concentration of

risks! Parent of insurer may keep some risk(s) entirely or the tail risk(s)

Some Reinsurance Solutions for Fair Value Risks

Includes variable annuities, indexed annuities, etc…

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Counter-party risk present Complicated structured finance solutions Volatile fair value marks unpopular with analysts Reinsurer and ceding company have different view of risk

Draw conclusion that base contract + rider are under priced. Real world v. risk neutral

Market capacity is low Lack of secondary market lack of opportunity to make money?

Challenges with Reinsuring Fair Value Risk

Often begin with differing views on measurement of risk…

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Reinsurers also want profitable business, too!

Thank you for your attention.

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