Best practices in reporting and forecasting October 2017

Capital Generation disclosures Best practices in reporting and forecasting October 2017

Introduction Free Capital Generation (FCG) With the introduction of Solvency II (SII) in January 2016, the solvency ratio has become an important metric for the performance and position of insurance companies in Europe. Although Solvency II reporting is primarily aimed at prudential reporting to the regulator, the importance of Solvency II reporting and Free Capital Generation in particular is eminent for all stakeholders and investors in particular. Rather than being a regulatory framework only, Solvency II has evolved as a new framework for reporting on the value of insurance companies. In this context, historical IFRS or EEV/MCEV related concepts such as Net Asset Value or Value in Force are losing importance in investor communication. Under Solvency II, Free Capital is the amount of available own funds in excess of the regulatory required capital (or the capital expected by the market). Free Capital Generation (FCG) is the amount of Free Capital that is generated by an insurance company. The higher the FCG, the higher the potential dividends, and the higher the opportunities to invest. This makes FCG is a highly relevant framework for investors and other stakeholders. Scope All members of the CRO Forum that have an interest in SII disclosures, supplemented with the large Dutch Insurance companies (see appendix for the full list). Scope This survey shows the industry s position on: Disclosures on Free Capital Generation Sustainability of Free Capital Generation Relation between Free Capital Generation and dividend payment Target Solvency ratios Relation between IFRS equity and SII own funds Opportunities to improve Free Capital Generation This survey explores how European insurance companies report on FCG in analyst presentations and other investor communications. 2

Contents 1 Concept of free capital generation Key messages: 1 Varying details in disclosures on development of SII ratio 2 SII reconciliation and free capital generation 2 Limited information on sustainable Free Capital Generation 3 Free capital generation outlook 3 4 No forecast provided for future Free Capital Generation Typically, 5-10% of the Free Capital is paid as dividend 4 Dividends and SII ratio 5 Dividend policies still strongly focused on IFRS metrics 6 Typical minimum SII ratio for dividend payment ~150% 5 Equity under IFRS and SII 7 Dividend is approx. 50% of the sustainable FC generated 6 Improving the free capital position 8 Most insurers (90%) report on difference IFRS / SII equity 9 Most insurers (~60%) took actions last year to improve FCG 3

1.1 Definitions for Free Capital Generation (FCG) Throughout this presentation, the following definitions will be used: 150%* SCR FC Free Capital Generation SCR Solvency Capital Requirement EOF TC FC Eligible Own Funds Target Capital (for example 150% of SCR) Free Capital SCR TC EOF FC FC 2016 Other Changes Dividend Paid 2017 A distinction can be made between elements that can be considered sustainable contributions to the FCG. Sustainable means: generated by the company on its own account and net of external and one-off effects. Other terminology that is often used for this is organic capital creation or operating capital creation, although the exact definitions may vary between companies. The actual change in the free capital position is also determined by non-sustainable elements: external circumstances or one-off actions. The threshold of 150%*SCR may vary between companies. For some graphs in this report a threshold of 100%*SCR is used for consistency. Note: SII is a prudential framework based on prescribed estimates like e.g. yield curve, contract boundaries, which does not necessarily correspond to an economic view. Therefore, Free Capital Generation (FCG) is by definition based on a regulatory calculation. 4

1.2 Sources of FCG Own funds (+) Expected investment return (+/-) New business (+) Release of RM SCR (+) SCR release (-) SCR new business (-) Transitionals (-) UFR drag (+) Release of TVOG (-) Financing costs Sustainable FCG Non-economic variance Economic variance Assumption changes Model changes Regulatory changes Management actions Actual FCG Dividend payment 5

2.1 SII ratio reconciliation This page shows the type of information disclosed when reporting the bridge between YE2015 and YE216 SII ratios. It shows whether a split is made between the sustainable FCG and non-sustainable FCG, and whether details were provided on what the company considers to be sustainable. Companies often do not split the change in solvency ratio in a part that they consider to be sustainable, and a part that was non-sustainable (left graph). Showing this split may give additional comfort to analysts on the stability of the SII ratio towards the future. Most companies that do provide information on the amount of sustainable FC that was generated, do not provide the underlying components (right graph). Without these components, investors cannot make their own analysis. Only some companies provide the detailed information in a forecast (separate from the SII reconciliation). Split shown sustainable vs non-sustainable? Companies providing details on "sustainable part" Yes 27% no 48% yes 52% No 73% 6

2.2 SII ratio reconciliation - components On the right is shown how much detail is provided in the bridge showing the SII reconciliation. Some companies report only the opening and closing position of the SII ratio (or Own Funds and SCR) without further explanation (0 steps), other companies use many steps (sometimes more than 9) to explain to analysts how the SII ratio, and thereby the FC, has evolved over the year. All of the companies analysed during this survey report on opening and closing SII ratios. The amount of information provided in the reconciliation varies strongly. Some companies only provide SII information in the annual report and SFCR, without providing additional information in analyst presentations. This may be because there is still insufficient comfort on the reliability of the information, making companies reluctant to public disclosure. Some companies only provide static SII information, without providing additional information in analyst presentations on the development of the SII ratio. Other companies use more than 9 steps to explain the movement of the SII ratio to analysts. The majority of the insurance companies in the survey shows 3 to 5 steps. Please see the next page for more information on the steps used for disclosure. # steps used in the reconciliation 9 8 7 6 5 4 3 2 1 0 0-2 3-5 6-8 >=9 7

2.3 SII ratio reconciliation - components Different components can be used to explain the movement in the SII ratio. This page shows how often specific elements are used either with a specific value (dark blue bars) or mentioned only qualitatively (light blue bars). When elements are mentioned only qualitatively, the values are usually shown combined with other elements. The level of detail in the disclosures is low. Important elements for analysts to forecast future FCG (e.g. excess investment returns, release of RM and SCR, UFR drag and the impact of new business), are most often not separately shown in the SII reconciliation. The focus is on explaining the variances (economic and noneconomic), one-off items and model changes, and the paid-out dividend. Because of the recent introduction of SII there are still many changes to models and methodologies. % of companies reporting the element in their SII reconciliation 0% 20% 40% 60% 80% (Excess) investment return New business Release of RM UFR drag TVOG release Dividend Financing costs (Net)SCR release Transitionals Non-economic variance Economic variance Assumption changes Changes of models Changes in regulation Participations (upstream dividends) One off items Other (details not disclosed) % reporting this item (as a separate value) in the S2 reconciliation % mentioning this item qualitatively (value is shown combined with other elements) 8

3. FCG outlook formal forecast Analysts are primarily interested in the ability to generate FC in the future. This page shows how many companies provide a formal forecast (a promise to investors) for future FCG. Irrespective of whether a forecast is made, an analysis was made what percentage of the FC generated last year is considered sustainable by the company. Only a small fraction (14%) of the companies provide a formal forecast of the expected future FCG (left graph). The average FC generated is just below 20% of their total FC at the reporting date (not shown in graph). The graph on the right shows a histogram of the sustainable FCG as % of the total available FC (here calculated as OF minus 100% SCR). For those companies reporting on the sustainable FCG according to the company s own definitions ( operational capital, sustainable capital, operating capital result, organic capital, etc.), that value is used for the histogram. For the other companies, an estimate is made based on the definitions shown on page 5. The median value reported is a FCG of 10% of the total available free capital at the reporting date. Formal forecast made? Yes 14% Sustainable FC generated last year as a % of available FC (OF minus SCR) No 86% 8 7 6 5 4 3 2 1 0 <0% >0% but <=10% >10% but <=20% >20% but <=30% >30% 9

4.1 Dividends and SII ratio Paying (predictable) dividends is essential for investors, while the regulator will require an adequate level of OF. This page shows how much FC is paid out as dividend (as a % of the total available FC top graph), and how this dividend payment impacts the SII ratio (bottom graph). Although SII is a constraint for most insurers, the majority express their dividend in terms of Net Profit. Dividend targets typically lie in range of 40-50% of Net Profit (not shown in graph). Dividends as percentage of free capital typically lie in range of 5-10%. On average dividend pay-out amount to a deterioration of more than 7% of the SII-ratio (bottom graph). Dividend as % of Free Capital (OF minus SCR) 16% 14% 12% 10% 8% 6% 4% 2% 0% Companies in survey Deterioration of SII-ratio following dividend pay-out 0% -2% -4% -6% -8% -10% -12% -14% Average: -7,6% Note that Old Mutual is not included in the graph due to fungibility restrictions leading to a different relation between the ability to pay dividend and the eligible own funds. 10

4.2 Dividend policy The factors explicitly mentioned in the dividend policy are a combination of IFRS and SII metrics, and strongly vary within the survey group. The top graph shows the percentage of companies using specific metrics as a basis for the determination of the dividend amount. The bottom graph shows the amount of dividend paid out in relation to the SII ratio The most frequently used metrics for determining the dividend amount are the IFRS profit and the solvency position (top graph). For many companies there is an explicit link between the SII position and the dividend amount in the dividend policy. The Free Capital Generation itself (as defined in this survey) is not yet observed as a metric. Although there there is an explicit link in the dividend policy between the SII position and the dividend paid, there is no clear relation (lower graph) between the actual amout of dividend paid out (as a % of the availabe Free Capital) and the Solvency II ratio. % of companies mentioning a metric in the dividend policy Strategic considerations Leverage ratio Regulatory requirements Liquidity position Solvency II ratio/capital position Operating result/income (IFRS) 0% 20% 40% 60% 80% Dividend (as a % of FC) vs SII-ratio 15% 13% 11% 9% 7% 5% 3% Note that Old Mutual is not included in the graph due to fungibility restrictions leading to a different relation between the ability to pay dividend and the eligible own funds. 1% -1% 100% 150% 200% 250% 300% 11

4.3 Dividend policy (Solvency II) Most companies express an ambition for their SII ratio and define limits as part of their capital management policy. The ambitions and limits are summarized on this page. Investors should not expect dividend payments below the given limits. The target SII ratio lie in the range of 160% to 200%. The graph show the company s target SII ratio, the upper boundary of their SII target, the lower boundary of their SII target and a dividend minimum. The lower boundary of their SII target sometimes serves as a dividend minimum. Several insurers relate their SII ratios to a desired external benchmark rating. Solvency II ratio, target ratio range, and minimum ratio for dividend payments 300% 300% 250% 250% 200% 200% 150% 150% 100% 100% 50% 50% 0% Current SII ratio SII Target High SII target Low SII target Dividend minimum 0% Two insurers only show their SII target value without an upper range. We assume a +20% points top range, shown in the graph for these two insurers as a bar without end cap. 12

4.4 Dividends and FCG The higher the FCG, the higher the amount of dividend that can be paid out. The amount of FCG that is paid to investors varies strongly over the companies. Dividend targets typically lie in range of 40-50% of IFRS Net Profit. Dividends as percentage of sustainable capital generation. On average insurers have paid out 51% of their sustainably FC generated. 75% of the insurers have paid out more than 33% 25% of the insurers have paid out more than 62% Dividend as % of sustainable capital generation (percentiles) 25% 25% 25% 25% 0% 20% 40% 60% 80% 100% 13

5.1 Equity under IFRS and SII - Components All companies need to report on the difference between IFRS equity and SII equity in the Solvency and Financial Condition Report (SFCR). IFRS and SII metrics both determine dividend payments. The relation between IFRS and SII is mainly provided in the reconciliation between IFRS equity and SII Own Funds. A large majority (90%) of companies report this reconciliation. These companies recognize several contributors to the difference in IFRS and SII equity; not every contributor is always disclosed (either because it does not impact the reconciliation or because it is not explicitly disclosed). Disclosed contributors to difference in IFRS & SII equity 0% 20% 40% 60% 80% 100% Revaluation of assets Revaluation of liabilities Deferred tax items Goodwill, DAC and intangible assets Treatment of participations and scope changes Other 14

5.2 Equity under IFRS and SII - Values All companies need to report on the difference between IFRS equity and SII equity in the Solvency and Financial Condition Report (SFCR). The different revaluations have different impact within the group. The main contributor is the revaluation of assets & liabilities, typically leading to SII OF to be larger than IFRS equity. Goodwill, DAC and intangibles decrease SII equity compared to IFRS equity. Sources of difference in IFRS equity & SII OF 175% Contribution (% of IFRS equity) 125% 75% 25% -25% Maximum 75 th Percentile Average Median 25 th Percentile Minimum -75% Revaluation of assets & liabilities Deferred tax items Goodwill, DAC and intangible assets Treatment of participations and scope changes Other Total 15

6. Improving the FC position FCG is essential for stable dividend payments and a stable SII ratio. Many different actions can be taken to improve the FCG, either on the short term or on the long term. All companies report on material events or actions that impacted the Solvency ratio. Most companies (62%) specifically address management actions that were taken (left graph), or will be taken in the near future, to improve the free capital position. Many different types of management actions are reported: actions to increase own funds (either through the assets or liabilities), actions related to restructuring, and actions to decrease the SCR. Dividends, equity, capital injection, securitisation OF (assets) actions SCR actions De-risking, ALM, Internal models, reinsurance, hedging, product mix Management actions addressed? No 38% Sale of entities, portfolios, legal entity structuring Restructuring OF (liabilities) actions Update of parameters, modelling Yes 62% 16

Thank You The contacts at KPMG in connection with this report are: Jeroen van Wageningen Financial Risk Management Partner KPMG Advisory N.V. Tel: +31 (0)20 656 42 09 E-Mail: vanwageningen.jeroen@kpmg.nl Jeroen Gielen Financial Risk Management Sr. Manager KPMG Advisory N.V. Tel: +31 (0)20 656 71 23 E-Mail : gielen.jeroen@kpmg.nl

Appendix I: Insurance groups in the survey Selection criteria The survey group consists of all CRO Forum members and large Dutch insurance groups. Insurance groups are excluded from the survey when: Solvency II is not the prevailing regulatory framework; When the financial structure does not require or incentivize reporting Free Capital Generation on Solvency II principles. Reporting The survey is based on reporting per YE2016, or HY2017 if available. Sources are the companies analyst presentations. Annual reports and SFCRs were used for additional information. Group members A.S.R. ACHMEA AEGON AGEAS ALLIANZ AVIVA AXA DELTA LLOYD GENERALI GROUPAMA HANNOVER RE LEGAL & GENERAL MAPFRE MUNICH RE NN GROUP OLD MUTUAL PRUDENTIAL RSA SCOR UNIPOL SAI UNIQA CRO Forum members AIG, LLOYD S, SWISS RE and ZURICH, and Dutch insurer VIVAT, were not included in the survey because of the selection criteria. 18

Appendix II: Glossary Actual FCG Economic variance FCG (Excess ) Investment return OF Non-economic variance RM RM release SCR SCR release SFCR Sustainable FCG TVOG The amount of free capital that is generated by the company in a certain period. This will be the net effect of the Sustainable free capital generation and external/one-off effects. A change in FCG because the market conditions evolved different from what was expected. Free Capital Generation The investment return that is expected on the asset portfolio that exceeds the risk free rate used for discounting the liabilities. Own Funds A change in FCG because the portfolio evolved different from what was expected. Risk Margin as defined by Solvency II. Release of risk margin (RM) over time due to run-off of the portfolio. Solvency Capital Requirement Release of required capital (SCR) over time due to run-off of the portfolio. Solvency and Financial Condition Report The amount of free capital that is generated by the company on its own account and net of external- and one-off effects. Other terminology used is: organic capital creation, operating capital creation. Time value of options and guarantees; typically only a small contribution to the FCG. 19

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