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Inside magazine issue 12 | Part 03 - From a corporate perspective Figure 5: Duration mismatch 20 15 Duration of liabilities 10 5 RO 0 0 5 DE NL LU FR BE ES IT 10 Duration of assets UK 15 20 In non-life insurance business, the impact on the financial result increases the pressure on the underwriting margin, leaving no leeway to offset unexpected high losses due to catastrophe claims against the financial result. In this context, M&A deals become very attractive as it is a way of reducing costs, increasing the level of diversification and, therefore, boosting long-term profitability. Finally, the low levels of catastrophe claims during the year generated an excess of capital in the market. Subsequently, if there is a weak financial result and no dividends are paid to shareholders, this might push the RoE further down, increasing pressure on margins for non-life (re)insurance business. Source: EIOPA Financial Stability Report December 2015 Figure 6: Joint mismatch between IRR and duration Duration mismatch (assets minus liabilities) Dur. Asset > Dur. Liab & IRR Assets < IRR Liab Dur. Asset < Dur. Liab & IRR Assets < IRR Liab DE BE FR UK NL LU IT ES Dur. Asset > Dur. Liab & IRR Assets > IRR Liab Dur. Asset < Dur. Liab & IRR Assets > IRR Liab Key indicators to monitor profitability In order to be able to offer a competitive return to policyholders and cover obligations, insurance undertakings have to carefully monitor certain key indicators and develop new strategies to optimize the financial and technical return, taking into account the underlying risk. To assess the profitability of an insurance undertaking or to value the return of a portfolio requires specific technical ability to: •• Identify future profits related to the insurance liabilities in a prospective manner •• Consider the cost of the capital which is tied up to cover the risk arising from market and underwriting risk, based on the new Solvency II regime -3 -2 -1 IRR mismatch (assets minus liabilities) 0 1 2 3 •• Manage interactions between assets and liabilities with an economic and best estimate vision. Source: EIOPA Financial Stability Report December 2015 Some key indicators of profitability commonly used in the insurance business are more applicable to life business than non-life business. The relevance of these metrics also depends on the target audience (investors, policyholders, management, regulatory supervisors, etc). 124
Inside magazine issue 12 | Part 03 - From a corporate perspective Key Indicators Description Focus MCEV “The Market Consistent Embedded Value is a measure of the consolidated value of shareholders’ interests in the covered business.” (CFO Forum) The future business is excluded from the MCEV. CoR The Combined Ratio is calculated by dividing the sum of incurred losses and expenses by the earned premiums. When this ratio is below 100 percent, it means that the undertaking is making an underwriting profit (the company received more money in premiums than it paid in claims). This ratio does not take into account the investment income. The combined ratio is one true measure of the insurer’s profitability, as it takes into account the loss ratio, the expense ratio and the policyholder’s dividend ratio. It is particularly useful for monitoring business lines in non-life insurance companies. PVFP “The Present Value of Future Profits reflects the intrinsic value of financial options and guarantees on in-force covered business.” (CFO Forum) The PVFP represents the present value of anticipated profits from in-force insurance contracts. RoE The Return on Equity (RoE) is equal to the Net Income over the Shareholders’ Equity. This indicator allows a comparison to be made of the profitability of different entities, as it reveals how much profit is generated with the equity invested by the shareholders. EVA The Economic Value Added. EVA = Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital). The EVA corresponds to the realized profit in excess of the cost of capital. It means that value is added when the realized return is above the cost of capital. RAROC The Risk Adjusted Return on Capital. The RAROC is a risk-adjusted profitability indicator. It is the expected return/economic capital. RORAC The Return on Risk Adjusted Capital is calculated as the net income divided by the allocated risk capital. The RORAC is similar to the RAROC; in this case, however, it is not the rate of return that is adjusted for risk, but rather the capital. NBM The New Business Margin represents the created value arising from new business or additional premium. It is calculated as VNB/PVNBP, i.e. the profit on new business over the Present Value of New Business Premiums. The higher the ratio, the higher the portion of the premiums that accrue to shareholders as profit. Life insurance business Non-life insurance business 125
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Inside magazine issue 12 | Contents
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Inside magazine issue 12 | Foreword
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Inside magazine issue 12 | Part 01
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Page 74 and 75: Inside magazine issue 12 | Part 02
Page 144 and 145: Inside magazine issue 12 | Contacts
Page 146: Our expert authors, who are brimmin
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