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Actuarial Society of Hong Kong Standard Life Investments Dr. Bruce Porteous, Investment Director Insurance Solutions Standard Life Investments 16 November 2017 This communication is for Institutional Investors, Professional Investors and Accredited Investors only and should not be distributed to or relied upon by retail clients. It is only intended for use in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required.

Agenda Update on European insurers asset allocation trends Comparison with Asia Pacific insurers Investment Risk Performance Metrics under Solvency II Impact of Solvency II on Asset Allocation and Investment Strategies Private credit and illiquidity premium case study Liquid credit Solvency II optimisation case study Protected equity case study Absolute return case study Implications of IFRS17 On asset allocation and investment strategies Conclusions 2

Update on European Insurers Asset Allocation Trends 3

Update on European Insurers Asset Allocation Trends Source: Standard Life Investments 4

Update on European Insurers Asset Allocation Trends Insurers focused on significant changes to strategic asset allocation: 43% expect to increase their investment risk appetite 51% expect to decrease sovereign fixed income 60% expect to increase allocations to real estate and / or alternatives Alternatives: Infrastructure, commercial real estate loans, hedge funds, private equity, commodities Source: Standard Life Investments 5

Update on European Insurers Asset Allocation Trends Outsourcing asset management is increasingly attractive 44% of insurers are looking to outsource one or more asset classes 45% of insurers suggest that the low-rate environment makes it more likely that they will outsource to external asset managers Source: Standard Life Investments 6

Asian Insurers asset allocation trends Insurers intend to increase allocations to alternative assets and global equities The survey revealed the drivers behind these intentions and the barriers they need to overcome in implementing this strategy 75% of total assets invested are made-up from allocations to cash, bank deposits and fixed income securities 78% of insurers intend to increase exposure to infrastructure 75% seek to increase private equity 64% are looking to add to real estate Current asset allocation 28% 7% 10% 22% 31% 32% 30% 18% 49% 25% 14% 30% 23% 16% 30% 18% 6% 10% 10% 7% 13% 9% 19% 9% 11% 4% 8% 13% 4% 26% 20% 8% 19% 4% 26% 15% 6% 8% 6% 6% 12% 8% 6% 8% China Hong Kong Taiwan S. Korea Japan Australia Asia Domestic Sov. FI Domestic Corp. FI Oversea Sov. FI Dev IG FI Other FI Equity LT Deposits & Cash Alternatives Other Source: Standard Life Investments Asian Insurer Survey 2017 7

Asia Pacific Theme 2: The dual role of alternatives In search of higher returns The fall in yields on fixed income securities has driven insurers to consider increasing allocations to equities and alternative assets Different alternative asset classes bring different benefits, but in all cases investors expect higher returns through the harvesting of illiquidity premiums Proportion of insurers expecting future allocation to increase minus proportion of insurers expecting future allocation to decrease for each asset class Domestic Sov. Fixed Income Domestic Corp Fixed Income Overseas Sov. Fixed Income Dev. IG Fixed Income EM Corp Fixed Income Regional Equity Global Equity Cash Infra. Real Estate Private Equity China -33% -33% 0% 0% 0% 36% -33% -17% 100% 67% 100% Hong Kong 0% -25% 0% 25% -100% 33% 0% 0% 75% 67% 80% Taiwan 0% -33% 33% 25% 0% 20% 60% 0% 50% 33% 50% South Korea -100% -100% 100% 0% 0% 0% 0% 0% 100% 100% 100% Japan -67% 50% 50% 67% 0% -50% 50% 0% 100% 0% 50% Australia -10% 20% 100% 100% 0% -14% 100% 0% 50% 50% 0% Source: Standard Life Investments Asian Insurer Survey 2017 8

Risk and Investment Performance Metrics under Solvency II 9

Risk and investment performance metrics under Solvency II Assess against insurer s preferred metric, for example: Expected return per unit of SCR Performance assessment: Based on performance metric/objective, not risk premium or market spread Net of investment management fees, etc Capital assessed on a marginal basis, or on a stand-alone basis? Reflect disclosed targets for capital coverage and balance sheet volatility 10

Default adjusted yield/scr Managing credit in the context of Solvency II Risk and return driven by SCR either SF or IM 0.80 SII capital efficiency driven by Rating Duration 0.60 Idiosyncratic spread Liquidity 0.40 Balance sheet 0.20-0-5 5-10 10-15 15-20 AA AAA 20+ BBB A Rating SII considerations drive decision making at each stage of the asset management process: Asset allocation Portfolio construction Portfolio management Duration Analysis as of CoB31Jan17, representative portfolio of public and private credit assets. Market yields, EIOPA PD haircut Source: Standard Life Investments 11

Phoenix case study 12

Millions Millions Liability Aware Credit Investing: Cash flow matching 250 200 Annual cashflows Liabilities Typical liability cashflow profile Either annuity cashflows or fixed /stable component of participating business 150 100 50 Asset allocation Portfolio composition (public/private/oseas) determined by strategic asset allocation Either client view or in consulation with SLI 0 2016 2026 2036 2046 2056 2066 Assets Liabilities 5,000 Cumulative cashflows 4,000 3,000 2,000 1,000 0 2016 2026 2036 2046 2056 2066 Cumulative assets Cumulative liabilities Stock selection Portfolio construction Portfolio management investible universe of favoured credit determined by credit portfolio manager Use proprietary optimisation techniques to construct optimal portfolio subject to relevant constraints Able to construct optimal portfolio on a range of metrics: net spread, SCR, cashflow match Ongoing management by credit PM Combining PM expertise and judgment with relevant quantitative insurance focussed metrics e.g. hurdle rates, SCR based risk/return metric, cashflow match This slide is for illustrative purposes only and shows a sample cash flow matched portfolio. Source: Standard Life Investments 13

Impact of Solvency II On asset allocation and investment strategies 14

Prudent person principle Report Identify Measure Diversify asset holdings Restricted use of derivatives Risks of the asset class Control Manage Monitor Prudent limit for offmarket assets Invest with regard to liabilities 15

How have European Insurers reacted? 1. Increasing risk appetite High Yield Credit, Direct Real Estate, Equities Adding market tail risk protection to improve capital-efficiency of risk assets 2. Seeking diversification Absolute Return strategies, Alternative Risk Premia, 3. Monetising illiquidity premium Commercial Real Estate Lending, Infrastructure Debt,... Rotation from private to public credit Cashflow matching and Buy and Maintain 16

European Insurer Asset Allocation Case Studies 17

Private Credit and Illiquidity Premium Case Study 18

Private credit: Insurer allocations Some insurers are making significant allocations to private credit asset classes Commercial Real Estate Debt (usually senior, c. A-rated) Private placements, mortgage debentures Infrastructure debt Expectation these assets will yield an illiquidity premium and superior risk-adjusted returns For SII Matching Adjustment business, illiquidity premium estimate can be incorporated into discount rate for reserves And provide credit diversification And duration lengthening Source: Standard Life Investments 19

Credit universe Return Traditional Alternative Niche Distressed Debt Secondary Bank Loans/Pools Real Estate Loans Regulated and Social Infrastructure Syndicated Corporate Loans Emerging Market Debt High Yield Debt Specialised Finance Aviation Shipping Leasing Niche Bank Financing SME Loans Consumer Loans Real Estate Loans Real Asset Private Debt Asset Backed Securities Direct Lending G7 Treasuries UK Investment Grade Credit Non G7 Sovereign Debt Global Investment Grade Credit Commercial Real Estate (CMBS) Residential Real Estate (RMBS) Collateralised Loan Obligations (CLOs) Asset-backed Consumer Loan Pools (ABS) Real Estate Subordinated Lending Junior Debt/Mezzanine Cash Low Loss Severity Capital Preservation Source: Standard Life Investments Higher Loss Severity Alpha Seeking Credit 20

Challenges of Illiquid assets under Solvency II Fair valuation, including the assessment of valuation uncertainty and its impact on prudent valuation Base and stress Objective and transparent De-composition of spreads into credit and liquidity Standard and Internal Model Approaches to Solvency Capital Requirement for unrated assets Use of internal credit rating processes Consistency with implied behaviour of fair value methodology under stress Intense supervisor scrutiny 21

Update on European Insurers Asset Allocation Trends Private credit assets will usually not be rated by an external credit rating agency Insurer, possibly with assistance of their asset manager, may use internal credit rating processes in their Solvency II Matching Adjustment calculation and capital modelling Asset Manager Insurer Methodology Due diligence and on-going oversight Triggers for Review Calibration Investment Process and Internal Rating MA Fundamental Spread Management Information Back-testing Governance Internal Model SCR Source: Standard Life Investments 22

Relative value of commercial real estate debt Illiquidity premium in excess of 200 bps Source: Standard Life Investments, January 2017 Commercial Real Estate Debt offers an attractive illiquidity premium 24

Liquid Credit Solvency II Optimisation Case Study 25

Mismatch DV01 Liability Aware Credit Investing: ALM considerations 0 0.80 0.60 0.40 0.20-0-5 5-10 10-15 15-20 BBB A AA AAA 20+ Liabilities Asset allocation Managing against yield curve exposure of best estimate liability cashflows Expressed in terms of DV01 ladder looking at exposure across curve Investment in specific fund based on insurer specific risk and return appetite: e.g. net yield vs SCR -2,000-4,000-6,000-8,000 Residual risk Unlikely that duration and curve exposure of fund is consistent with underlying liability No desire to hold capital against this unrewarded risk exposure. -10,000-12,000 4,000 2,000 0-2,000-4,000-6,000-8,000 1 5 10 15 20 30 40 50 Fund Liabilities Maturity Hedge construction Portfolio management MAI Structuring desk manage portfolio of derivatives and cash assets to hedge residual curve risk Focus on efficient implementation Credit fund managed as mandated Overlay managed to ensure efficient deployment of liquidity and risk budget Cognisant of economic mismatch as well as SII capital considerations 27

Protected Equity Case Study 28

Expected Return in excess of Cash at Day 1 Tail risk protection and capital-efficiency 4.5% 4.0% The SCR s focus on tail risk means that option-based strategies can improve the capital-efficiency of risk assets 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 0% 10% 20% 30% 40% Standard Formula Equity SCR Note the Standard Formula may not capture all risks inherent in the option strategy Basis risk, implied volatility risk This analysis does not consider transaction costs involved in buying options Collar strategies buy puts for protection and sell calls to help finance put purchases Can reduce SCR by circa 40% At a performance drag cost of circa 150 bps pa Equities and Put Option Equities and Cash 29

Absolute Return Case Study 30

Absolute Return Illustrative funds by risk expectation Low Risk Medium Risk Return target Cash + 3% Cash + 5% Risk expectation 2% 4% 4% 8% Ideas universe Bonds and FX Macro Multi-Asset Macro Current availability Global Global Institutional SICAV fee 45bps* 85bps Broad investment freedom enables return to be generated irrespective of the environment Risk-based portfolio construction to ensure a robust portfolio Longer investment time horizon exploits established inefficiencies * After institutional fee rebate. Return expectations gross of fees annualised over rolling 3 year periods. Risk measure is annualised volatility Source: Standard Life Investments 31

Historical scenario analysis Retrospective stress testing of medium risk expectation fund MSCI World (EUR) move over same period* Fund simulated performance (current positions) % move -24-22 -20-18 -16-14 -12-10 -8-6 -4-2 0 2 4 6 8 10 12 14 16 Black Monday 1987 Gulf War 1990 Rate Rise 1994 Mexican Crisis 1995 Asian Crisis 1997 Russian/LTCM Tech Wreck (April 07-14, 2000) Sept 11th Equity Sell-Off (August 23 - October 09, 2002) Equity Rally (October 10 - November 27, 2002) Gulf War 2 (March 01-23, 2003) Bond Rally (May 01 - June 13, 2003) Bond Sell-Off (June 14 - July 31, 2003) Emerging Market Sell-Off 2006 (May 01 - June 08, 2006) Subprime Debacle 2007 (July 15 - August 15, 2007) Bank Meltdown 2008 (September 12 - October 15, 2008) Euro Crisis (July 22 - August 23, 2011) QE jitters (May 22 - June 24, 2013) China devaluation (August 10 - August 25, 2015) Global slowdown fears (December 31, 2015 - February 11, 2016) * MSCI World Returns prior to 2000 denoted in European currency units, except for 1987 which is denoted in German Marks. Source: Standard Life Investments 32

Standard Formula SCR Medium Risk Solvency II Standard Formula SCR End-June 2017 40% 35% 30% 25% 20% 15% 10% 5% 0% Interest Rate Equity Property Credit Currency Diversification TOTAL Source: Standard Life Investments 33

GARS Solvency II Standard Formula SCR (Estimate) Medium Risk Solvency II Standard Formula SCR: History 30% 25% 20% 15% 10% 5% 0% Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Quarter End 34

Standard Formula SCR Low Risk Solvency II Standard Formula SCR End-June 2017 25% 20% 15% 10% 5% 0% Interest Rate Equity Property Credit Currency Diversification TOTAL Source: Standard Life Investments 35

ARGBS Solvency II Standard Formula SCR (Estimate) Low Risk Solvency II Standard Formula SCR: History 25% 20% 15% 10% 5% 0% Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Quarter End 36

Implications of IFRS17 On asset allocation and investment strategies 37

IFRS 17 European insurers are still trying to understand the implications and how to implement Currently developing approach papers, building project plans and teams, estimating high level financial impacts Unlike Solvency II, IFRS 17 is principles based Data requirements are expected to be onerous and very expensive to implement Identification of blocks of business by profitability IT systems will require major changes 38

IFRS 17 Shape of profit emergence will change and will be spread more uniformly over the expected lifetime of the business Contractual service margin Up front profits will be eliminated Up front losses recognised immediately Mark-to-market valuations will increase P & L volatility, expose loss making business and asset/liability duration mismatches Risk-based solvency is expected to be a bigger driver of strategic asset allocation moves Transition is likely to be extremely complex and an area where divergences in treatment may emerge 39

Conclusions 40

Conclusions European insurers working hard to cope with low interest rate environment A sub-theme of evolving business models, especially life insurance Illiquids/private market assets is a big theme, as is capital efficient increasing risk appetite A sub-theme of supervisory scrutiny Development of sophisticated and bespoke investment performance metrics Accounting modernisation not expected to impact Strategic Asset Allocation greatly Risk-based solvency a greater driver 41

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