NET ASSET VALUE (NAV)
The net asset value is the market value of assets allocated to the covered business, which are not backing liabilities from the covered business.
The net asset value is calculated as the statutory equity capital, adjusted by the unrealised gains or losses on assets covering the equity capital that are attributable to shareholders after taxes. Dependingon local regulatory restrictions, equalisation reserves are also included in the net asset value. Intangible assets are not accounted for in the net asset value.
The net asset value is further split between the required capital (RC) and the free surplus (FS).
REQUIRED CAPITAL (RC)
The required capital is the market value of assets, attributed to the covered business – over and above that required to back liabilities for covered business – whose distribution to shareholders is restricted. Swiss Life bases the amount of required capital on 150% of the statutory solvency level according to Solvency I, except for assumed external reinsurance where an economic approach is used instead.
The amount of required capital disclosed is presented from a shareholder’s perspective and thus is net of funding sources other than shareholder resources (such as subordinated loans or unallocated bonus reserves).
FREE SURPLUS (FS)
The free surplus is the market value of assets allocated to, but not required to support, the in-force covered business at the valuation date. The free surplus is calculated as the difference between the net asset value and the required capital.
Under the chosen definition of required capital, the free surplus, unlike the required capital, is supposed to be immediately releasable and hence does not affect the frictional costs of required capital.
VALUE OF IN-FORCE BUSINESS (VIF)
The value of in-force business consists of the following components:
1. Certainty equivalent value (CEV)
2. Time value of financial options and guarantees (TVOG), including the cost of credit risk (see below)
3. Cost of residual non-hedgeable risks (CNHR)
4. Frictional costs of required capital (FC)
In the MCEV Principles, the term present value of future profits (PVFP) is used instead of certainty equivalent value.
Certainty equivalent value and time value of financial options and guarantees are items that involve projections encompassing local statutory liabilities and assets in line with:
– local legal and regulatory obligations
– company practice due to commercial and competitive constraints
– local market practice in the calculation of embedded value
CERTAINTY EQUIVALENT VALUE (CEV)
The certainty equivalent value is defined as the present value of the future shareholders’ statutory profits (net of tax) under the certainty equivalent scenario.
In this particular scenario, future market returns are determined as the forward rates implied in the reference rates at the valuation date. Discounting is performed at the same reference rates. The certaintyequivalent value includes that part of the value of financial options and guarantees which materialises in the underlying scenario.
The rules for anticipated management and policyholders’ actions applied in the certainty equivalent scenario are the same as those for the stochastic projection used to determine the time value of financial options and guarantees.
TIME VALUE OF FINANCIAL OPTIONS AND GUARANTEES (TVOG)
The certainty equivalent value does not allow for the risk that the financial outcome for shareholders could differ from the one implied by the certainty equivalent scenario. This is of particular relevance when products or funds include guarantees or options for the policyholder such as:
– guaranteed interest rates
– discretionary profit sharing and regulatory constraints, e.g. “legal quotes”
– maturity guarantees
– guaranteed minimum death benefits
– guaranteed annuity options
– surrender options
For such products or funds, a stochastic projection has been run allowing for the range of possible scenarios for financial markets. The TVOG is calculated as the difference between the average present value of shareholder cash flows (profits or losses) and the certainty equivalent value, plus the cost for credit risk (see remarks on credit risk below). The TVOG therefore represents the additional market consistent value of those financial options and guarantees in excess of the intrinsic value which are already allowed for in the certainty equivalent value.
At the end of the projection, shareholders are assumed to meet any shortfall of assets against liabilities or to receive a share of any residual assets. The same applies to the certainty equivalent value.
The cost of credit risk accounts for the shareholder’s share of credit risk of investments in bonds that would have otherwise been unaccounted for in other MCEV components. It is defined as the present value of charges on the projected economic capital for credit risk.
The initial economic capital for credit risk is defined as the impact on the value of in-force business corresponding to the 99% expected shortfall of the credit loss from the actual bond portfolio over one year, due to the migration and default risk. The underlying credit risk calculations are performed using an internal model based on the CreditMetrics©2 methodology.
The economic capital for cost of credit risk has been projected based on mathematical reserves. An annual charge of 4% has been applied to the resulting projected economic capital.
COST OF RESIDUAL NON-HEDGEABLE RISKS (CNHR)
The cost of residual non-hedgeable risks for risk factors such as mortality, morbidity, expenses and lapse rates is calculated under a cost of capital approach. It is defined as the present value of annual charges on the projected economic capital for residual non-hedgeable risks.
The initial capital for the CNHR has been calculated in line with Swiss Life’s internal model. The corresponding economic capital is calculated by aggregating the stand-alone economic capital amounts that correspond to non-hedgeable risk factors, notably the following:
– recovery rates
– capital options
The drivers for projecting the economic capital for CNHR are generally based on the statutory solvency margin.
An annual charge of 4% has been applied to the resulting projected capital at risk. It represents the excess return or risk premium that a shareholder might expect on capital exposed to non-hedgeable risks.
In order to be consistent with the CFO Forum Principles, no diversification between hedgeable and non-hedgeable risks has been taken into account. Furthermore, no diversification effects between market units have been accounted for.
FRICTIONAL COSTs OF REQUIRED CAPITAL (FC)
The frictional costs of required capital for the covered business are defined as the present value of the costs incurred by shareholders due to investment via the structure of an insurance company (compared to direct investment as individuals), such as tax on profits generated by the insurance company or the costs of asset management. Other potential frictional costs such as agency costs or financial distress costs have not been taken into account in the frictional costs of required capital.
2 Copyright© 2009 JPMorgan Chase & Co. All rights reserved.
New business is defined as covered business arising from the sale of new contracts and from new covers to existing contracts during the reporting year, including cash flows arising from the projected renewal of those new contracts. Higher premiums in Swiss group life contracts from wage increases are not considered new business. The value of new business (VNB) reflects the additional value to shareholders created through the activity of writing new business during the reporting period.
The value of new business of a period represents the effect on the MCEV as at end of period from writing new business, i.e. it is the difference between the actual closing MCEV and the closing MCEV which would result if no new business had been written during the period. This is known as the “marginal” approach to value of new business. It applies to every MCEV component: CEV, TVOG, CNHR and FC. Legal constraints – e.g. “legal quotes” – or management rules often apply to books of contracts as a whole instead of individual contracts. That is why the value of new business can be dependent on the business in force before the writing of new business.
A “stand-alone” valuation for value of new business has been performed when the business in force is not affected by writing new business (for example for unit-linked contracts). In this case, the value of new business has been valued independently of the business in force.
The value of new business is generally calculated with economic scenarios and assumptions as at end of period.
All assets and liabilities reflect the actual positions as at valuation date.
The asset model used for the calculation of the MCEV differentiates three main asset classes:
– cash and fixed income instruments
– equity-type investments (including real estate)
All bonds and bond-like securities (such as mortgages) are modelled as fixed or floating government bonds. For all bonds, coupons and nominals have been recalibrated so that the valuation of the bonds using the reference yields converges to the observed market value.
Equities, real estate, participations and alternative investments (hedge funds and private equities) are modelled separately using appropriate indices for the corresponding currencies.
Current initial market values of assets have been taken where available (“marked-to-market”), or estimated where there is no reliable market (“marked-to-model”), for example by discounting unquoted loan and mortgage asset proceeds. Local regulatory and accounting frameworks (such as the amortisation of bonds or lower of cost or market principle) are reflected.
When a substantial share of the assets is held in foreign currencies, these foreign assets are modelled explicitly (including the foreign currency exchange risk).
Liabilities are valued in line with local statutory requirements generally using individual policy data. For projection purposes, policies of the same product with similar risk profiles are grouped together to form model points.
In accordance with the MCEV Principles (G3.4), hybrid debt allocated to covered business is valued by discounting the corresponding coupon and nominal payments (liability cash flows) with reference interest rates and spreads that would be used by capital markets for debt with similar characteristics. For the spread used see section 5.1.1. The approach is consistent with the fair value disclosed in the Notes to the Consolidated Financial Statements.
The MCEV is calculated using a risk-neutral valuation, based on market consistent and arbitrage-free stochastic economic scenarios. Under this approach, the key economic assumptions are:
– the reference rates
– interest rate and equity-type volatilities
– correlations between the economic risk factors
– inflation rates
The stochastic economic scenarios are generated by the economic scenario generator developed and provided by Barrie & Hibbert, a UK based financial consulting company. For variable annuity products a dedicated economic scenario generator is used.
The assets and liabilities within the Swiss Life Group are mostly denominated in Swiss francs, euros or US dollars. The economic scenarios reflect these three major economies, and since 2012, also British pounds and Canadian dollars, which are of lesser importance. The exchange rates and dividend yields are modelled as additional risk factors, as well as the inflation rates in each economy.
For the calculation of the MCEV and the value of the new business as at valuation date, 2000 economic scenarios are used, ensuring convergence of the results for all market units. For the calculation of the sensitivities and some steps in the movement analysis, some market units use fewer scenarios in connection with variance reduction techniques.
Anticipated dynamic management actions and policyholder behaviour mainly concern the following areas: profit sharing for participating life businesses, asset allocation and realisation of gains and losses, and assumed policyholder behaviour with regards to their contractual options. They are dependent on the economic scenario considered and reflect local regulations and type of business.
The crediting rules for policyholders are consistent with current company practices and local regulatory environments, in particular regarding the existence of a “legal quote”. They ensure that the statutory solvency rules (Solvency I, including stress tests if legally required in the country) and other legal requirements are fulfilled for each projection year.
The rules for future asset allocations are consistent with going-concern assumptions. Asset realignment avoids deviating from the strategic asset allocation by more than a predefined margin and takes place after each projected year.
Lapse rates from policyholders have been dynamically modelled. For traditional business, lapse rates depend on the difference between the credited rate to the policyholders and the anticipated policyholders’ expectations. Lapse parameters depend on the country and product line considered.
MCEV guidance requires that profits or losses incurred in service companies from managing covered business are measured on a “look-through” basis. This principle ensures that all profits and losses incurred in relation to the covered business are passed to the corresponding entity, and consequently incorporated into the value of in-force business.
The look-through principle is applied for asset management services and corporate centre services. The future profits or losses taken into account for these services are limited to those linked to the insurance business, after “legal quote” and taxes.
The Group MCEV for Swiss Life comprises MCEV results for covered business and IFRS net asset values for non-covered business.
Covered business comprises all of Swiss Life’s major life, health and pension business as well as assumed external reinsurance with the exception of Swiss Life Insurance Solutions AG, which is not material for MCEV purposes. In the case of France, the remaining operations are sub-consolidated with their IFRS net asset value and also included in the French covered business.
Covered business relates to the operations in:
– France: sub-consolidated
The sum of all market consistent embedded values for the market units of the covered business forms the total MCEV for covered business.
Non-covered business comprises all other entities of the Swiss Life Group that are valued at the unadjusted IFRS net asset value on a consolidated level, such as the distribution unit AWD or investment management, financing and holding companies. Non-covered business is added to the MCEV results from the covered business to form the Group MCEV.
Allowance is made for gains or losses arising from the defined benefit pension plans for Swiss Life’s own employees. In Switzerland there is a semi-autonomous pension fund with biometric risks coveredby an insurance contract. In other units the major part is covered by insurance contracts. The remaining part is modelled as commensurate expenses in the projections.
The costs of share-based payment programmes for employees are not included in the MCEV, other than to the extent that they are allowed for in the local statutory accounts upon which the shareholder net assets are based. Further information on the costs of share-based payment programmes is given in the Group’s IFRS financial statements.