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CIA General Meeting Chicago, Illinois October 19, 2006. Investment Analyst Views. Veritas Investment Research. Independent Unbiased Research Rooted in Forensic Accounting Based on Business Fundamentals Long-term Investment Horizon. What do investors want to do?. Measure earnings - PowerPoint PPT Presentation
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Investment Analyst ViewsInvestment Analyst Views
CIA General MeetingChicago, Illinois
October 19, 2006
Veritas Investment ResearchVeritas Investment Research
Independent Unbiased Research
Rooted in Forensic Accounting
Based on Business Fundamentals
Long-term Investment Horizon
What do investors want to do?What do investors want to do?
Measure earnings
Evaluate risk
Value the company
Evaluate how well management is investing the company’s capital
What tools do investors have?What tools do investors have?
GAAP F/S
Source of Earnings disclosures
Embedded Value disclosures
Notes to the F/S and MD&A, e.g.:CALM disclosuresReserve movementsFair values
What the Street doesWhat the Street does
Forecasting earnings by segment
Key drivers appear to be:Premium growth
Net Income margin
Forecasts are then used to plug into:Forward P:E analysis
Forward P:BV analysis
Relative Price : EarningsRelative Price : Earnings
Source: BMO Nesbitt Burns
Price : Book RegressionPrice : Book Regression
Why we don’t use these techniquesWhy we don’t use these techniques
The market doesn’t need a 15th EPS estimate
Target P:E multiples are difficult to justify theoretically
ROE regressions should be a means, not an end
Short term forecasts are inherently fraught with danger
Cause & effect(Dis)connect between market events and GAAP earnings
Veritas approach to life insuranceVeritas approach to life insurance
Profitability is driven by two key components:
Did the Lifeco sell profitable new business?
Existing book of business – did the LifeCo manage better or worse than model?
SOE: Earnings Quality Concerns?SOE: Earnings Quality Concerns?
Source of Earnings, Common Size Q1-F06
-40%
-20%
0%
20%
40%
60%
80%
100%
IAG MFC SLF
Income taxes
Other
Management actions andchanges in assumptions
Experience gains/losses
Impact of new business
Earnings on surplus
Expected profit on in-force business Source: Company reports and
Veritas calculations.
SOE - Returns on SurplusSOE - Returns on Surplus
Return on Assets Backing Surplus*, 2001-2005
Source: Company reports and Veritas calculations
* Simple average of opening and closing balances
2005 2004 2003 2002 2001
MFC 4.0% 4.3% 4.3% 4.2% 5.4%
SLF 3.7% 3.8% 3.3% 3.8% 5.9%
IAG 3.7% 4.4% 4.3% 3.1% 3.8%
SOE - “Core earnings”SOE - “Core earnings”
0.40 0.41 0.41 0.42 0.45 0.46 0.46 0.490.57
0.62 0.64 0.620.66 0.69 0.72
0.77
0.16 0.18 0.16 0.180.20 0.17 0.16 0.16
0.190.22 0.22 0.25 0.21
0.26 0.25 0.23
-
0.20
0.40
0.60
0.80
1.00
1.20
Q3F
04
Q4F
04
Q1F
05
Q2F
05
Q3F
05
Q4F
05
Q1F
06
Q2F
06
Q3F
04
Q4F
04
Q1F
05
Q2F
05
Q3F
05
Q4F
05
Q1F
06
Q2F
06
Expected profit Earnings on Surplus
MFC SLF
How is shareholders’ money invested?How is shareholders’ money invested?
Assets Backing CapitalAsset Mix Supporting Capital (and Other Liabilities) – Dec. 31, 2005
Source: Company reports, Veritas calculations
•Includes non-policy liabilities and shareholders' equity
** Includes shareholders' equity, long-term debt, liabilities for preferred shares and capital instruments and non- controlling interest in subsidiaries
Bonds Mortgages Stocks Real
Estate Total
GWO 66.0% 2.0% 17.4% 14.6% 100.0%
IAG* 68.8% 7.9% 11.6% 11.7% 100.0%
MFC** 62.1% 11.9% 23.5% 2.5% 100.0%
SLF* 78.4% 3.5% 7.1% 11.1% 100.0%
Allowances for future credit lossesAllowances for future credit losses
Key takeaways
Dollar amounts are much more significant than impaired loans MFC has been reducing its reserve GWO carries a lower reserve
Source: Company reports and Veritas calculations. IAG does not disclose this figure.
Note: Amounts in millions of Canadian dollars
As a Percentage of Bonds and Mortgages Supporting
Actuarial L iabilities
Dollar Value
2005 2005 2004 2003 2002
SLF $2,413 3.2% 2.9% 2.7% 2.3%
MFC $2,906 3.7% 4.3% 6.9% 6.8%
GWO $608 1.5% 1.3% 1.3% 0.8%
The Whole PortfolioThe Whole Portfolio
0%
20%
40%
60%
80%
100%
Q1F06 Q4F04 Q1F06 Q4F04 Q1F06 Q4F04 Q1F06 Q4F04
GWO IAG MFC SLF
Bonds Mortgages
Stocks Real estate
Cash and short-term investments Policy loans and other investments
Invested Asset Composition, Q4-F04 vs. Q1-F06
Bonds OnlyBonds Only
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Q1F06 Q4F04 Q1F06 Q4F04 Q1F06 Q4F04 Q1F06 Q4F04
GWO IAG MFC SLF
AAA AA A BBB BB & low er, and unrated
Bond Portfolio Composition, Q4-F04 vs. Q1-F06
Policy Liabilities - the RollforwardPolicy Liabilities - the Rollforward
Difficult to glean useful information
Source: MFC 2005 annual report
MFC Policy Liability Rollforward, 2005(Amounts in millions of Canadian dollars)
2005
1 Balance, J anuary 1 137,410
2 New polic ies 1,960
3 Normal in-force movement (3,676)
4 Changes in methods and assumptions (50)
5 Changes due to acquisition and assumption transactions 441
6 Currency impact ($4,036)
7 Balance, December 31 132,049
Assumption changes – MFC 2005Assumption changes – MFC 2005
EV ValuationEV Valuation
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
2001 2002 2003 2004 2005
BV EV Share price
MFC share price, EV/share, BV/share
P:EV MultiplesP:EV Multiples
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
1999 2000 2001 2002 2003 2004 2005
MFC SLF Industrial Alliance Canada Life European average
VNB Multiples (Implied)VNB Multiples (Implied)
-5.00
0.00
5.00
10.00
15.00
20.00
2000 2001 2002 2003 2004 2005
MFC SLF Industrial Alliance
Implied VNB GrowthImplied VNB Growth
Discount Rate MFC SLF
Price $36.06 $44.75
8.50% 0.96% 0.99%
9.00% 1.46% 1.49%
9.50% 1.96% 1.99%
VNB / Share GrowthVNB / Share Growth
-30%
-20%
-10%
0%
10%
20%
30%
40%
2001 2002 2003 2004 2005
MFC SLF
Industrial Alliance Grow th implied by VNB multiple of 15
SLF EV Growth AnalysisSLF EV Growth Analysis
VNB growth rates are not all that affect EV growth
The market discounts for EV adjustments – the risk inherent in managing the existing book of business
2000 2001 2002 2003 2004 2005
Opening EV, Jan 1 9,640 11,025 11,277 14,179 13,160 14,277
Expected growth (on in-force-business) 771 836 947 1,096 1,186 1,190
VNB 563 512 634 580 666 782
EV adjustments* 0 (803) (1,476) 329 645 625
Currency (9) 462 101 (1,744) (574) (596)
VNB +/- EV adj. and currency 554 171 (741) (835) 737 811
EV AdjustmentsEV Adjustments
Note: circles are annual summary; squares are individual components
-350%
-300%
-250%
-200%
-150%
-100%
-50%
0%
50%
100%
150%
200%
2000 2001 2002 2003 2004 2005 2006MFC - black
SLF - white
Investment ThesisInvestment Thesis
6%1.55% 11%
P rojected growth rate
Market implied growth rate
VNB / Share GrowthVNB / Share Growth
V-LIST BUYTarget: $43.50
Directly Forecasting EVDirectly Forecasting EV
Supplement with high level EV forecast:
Opening EV+ EV Accretion
+ Value of New Business-Capital Returned to Shareholders
Closing EV
3855: What’s My Number?3855: What’s My Number?
Vanishing earnings
Balance sheet volatility
Gains / losses on assets backing surplus
3855: Vanishing Earnings3855: Vanishing Earnings
Forecasted EPS is affected
Therefore, forecasted valuation is affected for those using P:E approach
BV will increase – how does this affect those using P:BV regression?
Does the change adversely affect management decisions?
3855: Balance Sheet Volatility3855: Balance Sheet Volatility
Assets backing surplus will be marked to market – GOOD!
Assets backing liabilities will be marked to market – Not so good.
Analysts taking a wait and see approach
3855: Gains on Assets Backing Surplus3855: Gains on Assets Backing Surplus
What is the “right” level?
Accounting is similar to banks’ for Investment Securities
Operating earnings / Core earnings
Analysts taking a wait and see approach
3855: New Disclosures, Please!3855: New Disclosures, Please!
Fair value of assets backing surplus, by asset class
Gains recognized in earnings & OCI separately, by asset class
Liability rollforward by quarter, separately showing effect of asset valuation
Other Requested DisclosuresOther Requested Disclosures
PfADs, reserve details
VNB / segment
SOE / segment
Experience gains or losses by type
Sensitivity to interest rates / equity markets
Questions and AnswersQuestions and Answers
LifeCo Fair Values - ExampleLifeCo Fair Values - ExampleFair Value of Assets Backing Equity, as at December 31, 2005
(Amounts in billions of Canadian dollars)
GWO IAG MFC SLF
Fair value of invested assets 93.6 12.8 173.1 105.4
Carrying value of non-invested assets* 12.8 0.8 12.6 12.3
Estimated fair value of total assets 106.3 13.6 187.7 117.6
Less:
FV of assets backing policy liabilities 76.5 10.1 136.5 84.6
Estimated fair value of non-policy liabilities 20.0 1.1 22.2 16
Estimated fair value of assets backing shareholders’ equity, net of other liabilities
9.8 2.3 29.0 16.4
BV of common shareholders’ equity 8.7 1.4 23.3 14.7
Excess of fair value of book value 1.1 1.0 5.7 1.7
As a % of BV 13.1% 72.3% 24.7% 11.2%
Market cap 25.5 2.6 56.8 26.2
Market cap/FV of equity 2.6 1.1 2.0 1.6
Source: Company reports and Veritas calculations.* Includes goodwill and intangibles.