NON TRADITIONAL ROLES FOR ACTUARIES

Wednesday, October 18 10:30 a.m. – Noon Session 131 PD

Specialty Track/Sponsor: Risk Management, Canadian Institute of Actuaries

The Actuary’s Role in Measuring, Monitoring and Managing Risks that are Traditionally Outside the Actuarial Domain [PD]

Moderator: Michel Rochette, FSA Panel: David T. Henderson, FSA, MAAA; Robert G. Lautensack, Jr., FSA Experience required: none

Take this opportunity to learn about risks that are traditionally outside the actuarial domain and their issues, such as poor data and bad assumptions.

You will:

Increase your understanding of how much reliance the actuary can place on non-actuarial sources;

Learn about controls that should be put in place to manage operational risks; and

Stay abreast of emerging techniques for measuring, monitoring and managing operational risks.

Coordinator: Anthony Dardis, FSA, FIA, MAAA

1

“The role of Actuaries in measuring, monitoring and

managing risks that are outside the traditional actuarial domain.

”Create the SolutionAnd Connect to the Business

Insert SOA06 The Power of Ideas header

• 3 Presentations:– Allan Levin, CFA, FSA, VP Core Rates

Structuring, Deutsche Bank– Michel Rochette, MBA, FSA, Staff Fellow at

the SOA. – Todd Henderson, VP and CRO of Western

Southern Life.– Q/A period.

SOA 06 Annual Meeting - 131PD, The Actuary's Role in Measuring, Monitoring and Managing Risks That are Traditionally Outside the Actuarial Domain

2

• Roles of Actuaries in Operational Risk:– Learning phase.– Part of an ERM Framework– Identification of the risk– Measurement or assessment of the risk exposure– Calculation of Economic Capital– Management of the risk: What do you do?

• Learning Phase:– Become familiar with what is going in the field of

operational risk elsewhere.• Attend Operational Risk Conferences: ERM Symposium. • SOA Library. Contact Ellen Bull.(EX.)• Other external sources• Let’s not reinvent the wheel but let’s adapt and learn the

language of the field.


3

• Learning Phase:– SOA Sources of Additional Information:

• Catastrophe Modeling: A new Approach to manage it by P. Grossi

• Operational risk: Modeling and Analysis. Theory and Practice by Dr. Marcelo Cruz.

• Operational Risk: Practice Approaches to implementation by Ellen Davis

• RMS’s section News letters. EX. CAS Working Party on Elicitation and Elucidation of Risk Preferences.

• GIRO Working Party (UK): Operational Risks, 2002

•


4

• Other External Sources of Information:– BIS website at www.bis.org and the operational risk

component of the Basle Capital Accord for international banks. (QIS and US QIS)

– Rating agencies: • Moodys’ Analytical Framework for Operational Risk

Management of Banks. • Fitch’s Bank Operational Risk Assessment Methodology• S/P: ERM framework

– Europe: Solvency II Working Parties, FSA in the UK with Integrated Prudential SourceBook (Chap 6) since January 2005.

• Other External Sources of Information:– NAIC new Risk Supervisory Framework– Federal Reserve Bank of Boston:

• Many papers on the quantification of operational risks. Advantages and disadvantages of quantification methods.(Free analysis!)

– Incisive Media Publications: http://www.opriskandcompliance.com/


5

• Identification of operational risk: Definition: (Drives all the rest!)

– Historically: • Every risk except Market and Credit. Too broad and Pre

Basel II and Solvency II in Europe. • Measure of link between business activities and variation in

business results( King 2001)

– Accepted definition in the BFS:• Risk of direct and indirect loss resulting from failed or

inadequate internal processes, people and systems, or from external events. It includes legal but excludes strategic and reputation risk.

• Comments on the definition:– Be consistent with the BFS:

• Easier comparison between our cos and by external rating and financial analysts.

• Actuaries could extend their reach in the BFS. • Larger definition inside our firm for ERM and Economic capital.• IAA Solvency Paper: Separates hazard risk from operational risk.

Different ways of slicing the pie!

– Operational risk is more than OPERATIONS RISK.– Direct and indirect losses, not opportunity losses (reputation risk)– Losses are classified by Root Cause and not the financial

consequences.


6

• Components of the definition:• 1st Process Risk:

– Risk Tolerance or Risk Appetite.– In the context of RISK is Opportunity (new

brand) this is an important role for actuaries.– SOX: ZERO TOLERANCE risk.

• Fraud or mistakes in the production and the reporting process of financial statements. (reserving process is part of that)

• Process risk controlled by legislation. • Subset of op risk.• Focused only on controls!


7

– COSO CUBE:

– COSO Framework:• Consideration of risk• Emphasis is really on controls. • Putting too much emphasis on controls

decrease the value of the firm.• Have to consider the cost and benefit of

reducing, eliminating or tolerating a given risk


8

– Role of actuaries in risk tolerance/appetite:• Will determine management response to risk• Should be clearly communicated to the marketplace.

– Ex. Management considers that as part of our operations, we will face at some point in the future some losses that are operational in nature in spite of our internal controls and approaches to managing this risk exposure.

– Management is willing to tolerate 1% of its equity as operational risk losses on a yearly basis.

• Will also help set the economic capital and reserve to anticipate the risk. Proactive instead of reactive.

• Risk tolerance or appetite would be set by actuaries instead of lawyers. (Mr. Spitzer should notice that!)

– Example of a risk response framework:


9

• Measurement and Assessment approaches.– Two broad categories:

• Qualitative methods.• Quantitative methods.

– Choice of approach:• Philosophy of the company• Objectives of the operational risk policy• Budget, team, time to realize.• Top down or bottom up approaches. • Regulatory constraints

– Overall, companies are implementing a group of methods, – Coordination by different groups: OP risk group, Audit,

Project management group, SOX group.

• Goals of measurement and assessment• Determine the operational risk exposure of your firm: • Methods can be used to improve operations, improve

performance• Control and manage the risk exposure: reduce losses.• Calculate some economic capital measure taking into

account the whole array of methods: – EX. IF a PMO is active, Then operational risk exposure from

process should be lower, thus resulting in a lower economic capital calculation.

• Protect the reputation of the firm.

– Idea: Use and Integrate a combination of methods. Can't be done in isolation. Not credible.


10SOA 06 Annual Meeting - 131PD, The Actuary's Role in Measuring, Monitoring and Managing Risks That are Traditionally Outside the Actuarial Domain

11

– Internal data to measure OP Risk Exposure:– Policy how on to measure these losses.– Start measuring direct and indirect losses.– Set a threshold: Above 10 000$.– Some of them – Ex. Fines – can be found in your

accounting system, – Others have to be estimated: Ex. IF System down for X

number of hours, Then Estimate direct and indirect loss. – Published financial statements contain in the notes some

information about some operational risk.

– Difficult at first: Resistance by employees and get the syndrome of: never did that before, why now?

– DATA


12

• Consortium Data for Insurance Companies• Operational Risk Insurance Consortium (ORIC)• Joint initiative by Association of British Insurers

and SAS. Similar to ORX and GOLD of BBA • Categorization of losses consistent with other

standards like Basle II.• Open to international insurers.• Contact ABI.

– List of current members of ORIC:• Allianz Cornhill • AXA • BUPA • Friends Provident • GE Insurance Solutions • HBOS • Hiscox Insurance • Insurance Australia Group • Just Retirement • Legal and General • Liverpool Victoria • NFU Mutual • Prudential • RBS • Skandia UK • Standard Life • St. Paul Travelers


13

• Economic Capital Calculation for INS OP. Risk

• Example to show that insurance co. face as much operational risk exposure as other FIs.

– Face fraud internally and externally– Operational incidents due to new products and services– Face process errors and mistakes in many functions:

pricing, reserving, underwriting, financial reporting.– Face human behavior– Subject to external events.– Subject to legal fines, lawsuits, class action suits.

• Insurance industry has a large exposure to op risk.

• Approach to calculation:• Published external sources of op. risk major losses (10k,

regulatory agencies, public lawsuits)• Mapped those major losses to the Basle II categories• Calculated the distribution of total unexpected losses

– Frequency based on Poisson – Severity based on a fat tail distribution (EVT)– Didn’t take into account the impact of “controls” nor recoveries– Determined the economic capital level at 99,9%.– Expressed results as a percentage of equity


14

Operational Losses: 2000-2005

0

5

10

15

20

25

300,

00%

0,30

%

0,60

%

0,90

%

1,20

%

1,50

%

1,80

%

2,10

%

2,40

%

2,70

%

3,00

%

3,30

%

3,60

%

3,90

%

% of Shareholders' equity at year-end

Num

ber

0,00%

20,00%

40,00%

60,00%

80,00%

100,00%

120,00%

Cum

ulat

ive

Op Risk Economic Capital% of Shareholders' Equity

,00%20,00%40,00%60,00%80,00%

100,00%

00,

922%

1,84

4%2,

766%

3,68

8%4,

610%

5,53

2%6,

454%


15

RatioTotal OPTotal ECName

14%5.4 b40 bIns. Co.13%4.5 b35 bJPMChase16%8.1 b52 bCitigroup

NAIC RBC capital has a requirement for business risk equal to 2% of life and health premiums, which would generate a capital of 561 millions, 10% of the previous calculations…Seems insufficient.

• Roles for Actuaries• Develop operational risk policies and internal

standards.• Coordinate risk and control self-assessment by

business units. Follow action plans.• Describe and model processes: reserving,

underwriting, investment.• Test scenarios of process failures. • Involvement in Sarbanes-Oxley.• Evaluate risk from outsourcing operations,

reinsurance in the case of insurance.


16

• Roles for Actuaries• Choose, develop, implement, maintain operational risk

technology.• Conceive forward-looking key risk indicators and relate to

internal losses.• Develop and implement a firm-wide operational loss

database of operational incidents.Model potential losses by appropriate methods and tools: frequency, severity, recovery.

• Develop new metrics to value operational risk exposure and effectiveness of controls.

• Coordinate business continuity planning in case of severe business disruption.

• Calculate economic capital and risk tolerance.

• Roles for Actuaries• Develop/review strategies to hedge operational

risk: corporate insurance, public operational hedging programs, risk derivatives, pooling arrangements, captives.

• Report on exposures, exceptions, financial values.• Evaluate the operational risks of new operations,

new products, new ventures..


17

• Final note:• Operational risk is becoming more prevalent in

the financial community due to both regulatory requirements and enhanced new corporate governance initiatives.

• Actuaries should be part of the development of this new risk management field, in part because of its similarities to insurance expertise.

• Final note:• Actuaries must be willing to work with a diverse

group of people• Be imaginative in adapting existing insurance

approaches to this new environment• Learn and enhance their tool set, in particular,

the more qualitative operational risk approaches.


1

Advantage: You

The Actuary’s Role in Measuring, Monitoring and Managing Risks that are Traditionally Outside the Actuarial Domain Session 131 PD

Society of Actuaries Annual MeetingWednesday, October 18, 2006 10:30am – NoonChicago, IllinoisTodd Henderson, FSA

Advantage: You

Risk Modeling Robustness

Lots of DataDynamic Models

Little or No DataCrude Models

Mortality & MorbidityInterest Rate

Credit

Customer BehaviorCompetition

Financial ReportingSystem Availability

Project DeliveryFraud


2

Advantage: You

Risk Modeling Robustness

Lots of DataDynamic Models

Little or No DataCrude Models

Financial

Operational

Advantage: You

“When looking at the top 30 corporate bankruptcies since 1980, approximately

75% appear to be related to some form of operational risk.”

Lawrence Moews, Chief Risk Officer, Allstate Insurance

Source: “Insurance Industry Risk LeadershipSurvey – Enterprise Risk Management Comes of AgeErnst & Young


3

Advantage: You

W&SFG Risk ModelGoals• Size Our Risk

• Enterprise• Line of Business

• Understand Our Risk• Contributing Factors• Diversification

• Prioritize Our Risk Management Actions

Pointed to the need to model all risks under a consistent analytical framework,i.e. a financial model for operational risks.

Advantage: You

W&SFG Risk Operational ModelFour Steps• Build Expert Judgment Based Models• Identify Experience Data Gaps

• Define Experience Data Requirements• Build and Populate Operational Risk Database• Build Experience Data Based Models


4

Advantage: You

Expert Judgment Based Risk Model

Identify Cause-Result

Event

Gather Expert

Opinion

Constructand Run Risk

Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

CauseFirst ConsequenceNext Consequence

Final (Financial) Consequence

LikelihoodSeverity

Based on Combined Responses

Feedback to Experts“What the Modal Says…”

Based on Combined Responses

Reasonable?If Not, What is?

Advantage: You



Event

Gather ExpertOpinion


Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

Reduced First Year PremiumFinal (Financial) ConsequenceLost Market ShareSecond Consequence

Inability to Process BusinessFirst ConsequenceNatural Catastrophe Cause


5

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

Multiple Experts Surveyed

Seven Questions

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

ImprobableRemoteGiven the controls in place, how likely is it that a single exposure will experience the cause?

1501How big is the exposure?

District OfficesHot SitesHow should the risk exposure be measured?

Response #2Response #1Question


6

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

LikelihoodRemote less than 1% 1 out of 200Improbable between 1% and 10% 1 out of 20Very unlikely between 10% and 25% 1 out of 6Unlikely between 25% and 40% 1 out of 3Toss up between 40% and 60% 1 out of 2Likely between 60% and 75% 2 out of 3Very likely between 75% and 90% 5 out of 6Probable between 90% and 99% 19 out of 20Virtually certain more than 99% 199 out of 200

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

$5,000$500,000The average case?

$0$0The best case?

$500,000 x two weeks

$1,000,000

$50 million x two weeks

$100,000,000

Should the cause occur, in light of the countermeasures in place, what is the worst case final consequence?

Response #2Response #1Question


7

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

Confidence RatingsVery confident, based on analysis of available dataConfident, based on experience and direct involvementSomewhat confident, based on observation and indirect

involvementNot very confident, based on extrapolated judgment with little or

no direct observationUnreliable, just a guess

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

Questions 1, 2 and 3Create Binomial Event Occurrence Probability Distributionfor Each Expert

Questions 4, 5 and 6Create Event Severity Probability Distribution for each Expert

Question 7Establish Weighting for Combining Separate Responses intoOne Loss Distribution


8

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

-$50,000,000-$45,000,000-$40,000,000-$35,000,000-$30,000,000-$25,000,000-$20,000,000-$15,000,000-$10,000,000

-$5,000,000$0

$5,000,000

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

What the Model Says is:• The Most Likely Outcome is a $0 Deviation in Premium;• There is a 10% Probability of a $7,600,000 Decrease in Premium;• There is a 5% Probability of a $10,300,000 Decrease in Premium; and• There is a 1% Probability of a $26,400,000 Decrease in Premium


9

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

Experts are Surveyed Again• Are these statements reasonable, and if not, what should be changed?

Advantage: You



Event



Model

ExposeModel

Results

AdjustExpertOpinion

Re-ConstructRisk

Model

If Model Deemed Reasonable• No Change

If Model Not Deemed Reasonable• Combine Responses, based on Previous Confidence Weighting• Recalibrate Loss Distribution


10

Advantage: You

The Actuary’s Role in Measuring, Monitoring and Managing Risks that are Traditionally Outside the Actuarial Domain Session 131 PD

Society of Actuaries Annual MeetingWednesday, October 18, 2006 10:30am – NoonChicago, IllinoisTodd Henderson, FSA


1

OTC Derivatives Trading and Structuring Derivatives for Deutsche Bank

Allan Levin CFA FIA FSA MAAAHead of Product Development – Core Rates Structuring

18 October 2006

DB Core Rates Structuring · 18 October 2006 · page 2

Agenda

Background

Counterparty Risk Trading

Core Rates Structuring


2


The Derivatives Market

$0

$25

$50

$75

$100

$125

$150

$175

$200

$225

$250

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

OTC Derivatives Outstandings*(Notional Amount in Trillions of US$)(2005 Data is through June 30, 2005)

Total IR and Currency Total Credit Default Swap Total Equity Derivatives


Trading Floor

Roles – Front Office

– Trading– Sales– Structuring– Research

Desks

– Risks– Client– Product– Asset Class


3


A Day on the Job

Extensive computer modeling

Pricing based on probabilities and the time value of money

Monitoring of risks and hedging where necessary

Discussions with internal / external clients


Agenda

Background




4


Counterparty Credit Exposures and CCDS

Loan Portfolio Managers were instrumental in the development of Credit Default Swaps to manage Loan Exposures.

Counterparty Risk Managers have been instrumental in the development of Contingent Credit Default Swaps to hedge Counterparty Credit Exposures.

DB uses CCDS to hedge Counterparty Credit Exposure related to a single and portfolios of OTC derivative contracts

DB is also an active market maker in the CCDS product.

DB’s CPM has a proven track record with Interest Rate and Cross currency swaps transacted with distressed and headline names, e.g. Tobacco, Autos, Auto parts, Asbestos, Merchant power. DB can provide a hedge for an otherwise illiquid position.


Contingent Credit Default Swaps (CCDS)

The same as regular CDS …

Contingent Credit Default Swap (CCDS) match the characteristics of traditional CDS in most aspects, eg Credit Events, Obligations, Deliverable Obligations etc.

… only with a variable notional

In contrast to regular CDS the notional of CCDS is not fixed but will change over time. It is linked to the market-to-market value (MTM) of a specified Reference Derivative, eg an interest rate or cross currency swap.

The Contract Notional of a CCDS will only be fixed if (and when) a Credit Event has occurred

The Contract is designed to hedge the counterparty risk associated with an interest rate or FX derivative transaction.


5


CCDS Mechanics

Premium payment

– Normally in cents upfront referenced to the underlying derivative notional

CCDS Notional

– Variable throughout the life of the trade– Will be fixed when the contract has been triggered at the time of the Credit Event– MTM to be determined via a dealer poll for the underlying the derivative

transaction– A positive MTM will cause the CCDS to have a notional > 0, a negative MTM will

cause the CCDS to have a notional of 0


Exposure ProfileGeneric 10-year Fixed Payer Swap, €10 mm notional

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

Jun-

04

Dec

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05

Dec

-05

Jun-

06

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-06

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-07

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-10

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11

Dec

-11

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12

Dec

-12

Jun-

13

Dec

-13

Expo

sure

(€ m

m)

E[MTM]+E[MTM]-E[MTM]


6


Pricing CCDS: Which Model?In the absence of a liquid market, CCDS must be priced with a model:

Compute the cost of hedging with liquid CDS, rates and FX products to maturity

Describe the hedging strategy and the associated assumptions and costs, i.e., a Black-Scholes style model that is dynamic and self-financing

The initial credit charge is to be spent on the dynamic hedging strategy. However, once the risk is hedged we should be indifferent as to whether the counterparty defaults or not

For a dynamic, intuitive hedging strategy the model must capture:The stochastic nature of credit spreads

The correlation between changes in credit spreads, rates and FX

The cumulative transaction costs associated with dynamically hedging to maturity


Hedging CCDS

1. Initial Credit HedgeWe need to use CDS to hedge at least the cash flows projected by current forward IR and FX rates. 2. Initial IR and FX HedgesWe need to hedge a proportion of the underlying interest derivative, such that, when the MTM increases due to IR and FX moves (thus credit risk increases) and we have to buy more CDS protection, we are compensated for the additional cost by the P/L on these hedges.3. Dynamic rebalancing of Credit, IR and FX hedgesCredit hedges must be adjusted in response to changes in IR and FX, i.e. the MTM on the underlying interest derivative. Conversely, IR and FX hedges must be rebalanced in response to changes in credit spreads. 4.Cross Gamma and CorrelationThe dynamic hedging strategy is indifferent to separate moves in credit spreads, IR and FX rates. However, the strategy is exposed to simultaneous moves. This is cross gamma risk and cross gamma P/L accumulates according to realized credit spread and IR/FX correlation


7


Examples

Credit exposure Chesapeake Energy CorpMaturity 10 yearsUnderlying 10 year Interest Rate Swap where

CHK pays USD floatingCHK receives USD fixed SA (ATM 10Y)

Price 20bp / 40bp paid upfront,

Credit exposure Ford Motor CreditMaturity 10 years Underlying 10 year Interest Rate Swap where

F pays USD floatingF receives USD fixed SA (ATM 10Y)

Price 66bp / 110C upfront


Agenda

Background




8


Product Development

Structured Assets– Enhancing yields– Subject to constraints, for example:

– Long duration– Appropriate accounting treatment

Structured Liabilities– Reducing funding costs

Asset-Liability Management Solutions– Assisting clients hedge their “nightmare” scenarios– In the most efficient or lowest cost manner– E.g. Out-of-the-money options on long-term interest rates


Product Example: Spread Range AccrualKey Features

Designed for investors who believe that the yield curve will notinvert, or if it does, will do so for only brief periods of time

Guaranteed high coupon for 1 year (Irrespective of the shape of the curve)

Subsequent coupons are based on the proportion of time that the 10 year Swap rate is greater than the 2 year Swap rate

The average level of curve steepness since 1989 has been 1.14%


9


Spread Range Accrual

Issuer AAA/Aaa

Settlement 3 weeks

Maturity 15 years

Issue Price 100.00%

Redemption 100.00%

Frequency Semi-annually, 30/360

Coupon Year 1 8.00% (Guaranteed 8.00% coupon on a AAA for Year 1)

Y 2-10 8.00% x N/DWhere:N = # of Calendar Days where the 10y swap - 2y swap is equal to or above 0

D = # of Calendar Days in Coupon Period

Call Provision 1 years from Settlement Date, thereafter semi-annually

Indicative Terms


Section 1

Historical Curve Steepness Positive slopes are typicalFlatness and inversion are unusual

The average level of curve steepness from January 1990 to present as measured by 10 year less 2 year Swap rates has averaged 1.14%

Out of 4293 business days, the curve has been inverted 6 business days and never below - 3.05 bps

Number of Days : CMS10 - CMS2January 1990 to September 2006 : 4293 business days

0369

12151821242730333639424548

-4bp

s

-2bp

s

0bps

2bps

4bps

6bps

8bps

10bp

s

12bp

s

14bp

s

16bp

s

18bp

s

20bp

s


10


The Federal Open Market Committee

10 Year less 2 Year Swap Levels(Sep 1989 to Sep 2006)

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Sep/

89

Sep/

90

Sep/

91

Sep/

92

Sep/

93

Sep/

94

Sep/

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Sep/

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Sep/

00

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Sep/

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Sep/

05

Sep/

06

US Federal Funds Target Rate(Sep 1989 to Sep 2006)

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%

Sep/

89

Sep/

90

Sep/

91

Sep/

92

Sep/

93

Sep/

94

Sep/

95

Sep/

96

Sep/

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00

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Sep/

06

Section 1

The Fed, Short Term Rates and Curve SteepnessThe curve generally steepens soon after the last tightening in the interest rate cycle. It is currently expected that the Fed is at the end of its rates tightening cycle

Fed rate hikes maintain pressure on the short end. They discourage buying in that sector and investors look for duration in the long end. This leads to curve flattening during a period of rate hikes

Once the Fed stops hiking, the pressure on the short end disappears; buying reverts to the short end and the slope steepens

The longer the Fed tightens, the more severe the market reboundswhen the Fed stops

The market is already pricing in a reversal of US monetary policy within a year of the last rate hike (see graph below)

Fed stops hiking

Overshooting Equilibrium Overshooting

Expected USD Three Month Libor Levels for the next Two Years (As Implied by the Current Yield Curve - Oct 2006)

4.6%4.8%5.0%5.2%5.4%5.6%

Oct

-06

Dec

-06

Feb-

07

Apr-

07

Jun-

07

Aug-

07

Oct

-07

Dec

-07

Feb-

08

Apr-

08

Jun-

08

Aug-

08

Oct

-08


Section 1

Flatness Forever?Market Implied Steepness

Current markets imply that the slope of the yield curve will remain relatively flat for the next 15 years

This is purely a reflection of the current shape of the curve, and is inconsistent with past experience

Expected future USD 3m Libor and 10y Swap Levels for the next 10 years (as implied by the current yield curve - Oct 2006)

0%

1%

2%

3%

4%

5%

6%

7%

8%

Oct

-06

Apr

-07

Oct

-07

Apr

-08

Oct

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Apr

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-10

Apr

-11

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-11

Apr

-12

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-14

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-16

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-16

Forward USD 3m Libor

Forward USD 10y Swap Rate


11


Historical versus Market Implied Steepness

Section 1

The slope of the curve from September 1989 to September 2006 was compared with that implied for the next 10 years by a market-consistent simulation

We projected 3,000 scenarios of forward curve steepness levels over the next 10 years using a market-consistent Monte Carlo simulation

The results indicated that the current market assumes an average curve steepness of 19 basis points (compared to the historical experience of 114 basis points) as well as an inverted curve 31.3% of the time (compared to the historical experience of 0.5%)

Accordingly, if we assume that future slope levels will be more consistent with that experienced in the past, structured product pricing will underestimate the price of steepener trades and overestimate the expectations of future curve inversion

Historical curve steepness has been much greater than that implied by the market currently

Implied Steepness Bands: 10yr less 2yr Sw ap Rates (Next Ten Years)

31.3%

20.1%15.5%

33.2% < 0.0%

0.0% - 0.25%

0.25% - 0.5%

> 0.5%

Historical Steepness Bands: 10yr less 2yr Swap Rates (Sep 1989 - Sep 2006)

0.5%13.2%

15.6%

70.7%

< 0.0%

0.0% - 0.25%

0.25% - 0.5%

> 0.5%


Agenda

Background



Disclaimer, Contact Details and Q.s


12


Disclaimer

The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but we make no representation or warranty, express or implied, with respect to the fairness, correctness, accuracy reasonableness or completeness of the information and opinions. We have no obligation to update, modify or amend this publication or to otherwise notify a reader in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.This presentation is provided for information purposes only. It is not an offer to sell, or a solicitation of an offer to buy, any security, nor to enter into any agreement or contract with Deutsche Bank AG or any affiliates. Any offering or potential transaction that may be related to the subject matter of this presentation will be made by a separate and distinct documentation and in such case the information contained herein will be superseded in its entirety by such documentation in final form. Any terms and conditions of any offering or transaction discusses herein are subject to change without notice.In addition, because this presentation is a summary only, it may not contain all material terms, this presentation, in and of itself should not form the basis for any investment decision.This presentation has not been approved for distribution to, or for the use of, private customers as defined by the rules of the UK’s Financial Services Authority. Financial instruments that may be discussed herein may not be suitable for all investors and any investors must make an independent assessment of the appropriateness of any transaction in light of their own objectives and circumstances, including the possible risks and benefits of entering into such a transaction. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. We therefore strongly suggest that potential investors seek their own independent advice in relation to any legal, tax, accounting or regulatory issues relating to the matters discussed herein. By accepting receipt of this presentation the reader will be deemed to represent that they possess, either individually or through their advisor, sufficient investment expertise to understand the risks involved in any purchase or sale of any security, referenced herein. If a financial instrument is denominated in a currency other than an investor’s currency, a change in exchange rates may adversely affect the price or value of, or the income derived from, the financial instrument, and any investor in that financial instrument effectively assumes currency risk. Prices and availability of any financial instruments described in this presentation are subject to change without notice. Analyses contained herein maybe based on assumptions that if altered can change the opinions expressed herein. Furthermore, past performance is not necessarily indicative of future results and nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument, credit, currency, rate or other market or economic measure.In the United Kingdom this presentation is approved and/or communicated by Deutsche Bank AG London, a member of the London Stock Exchange. In the U.S. this presentation is approved and/or distributed by Deutsche Bank Securities Inc., a member of the NYSE, the NASD, the NFA and SIPC. This presentation is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch. This presentation is distributed in Korea by Deutsche Securities Korea Co. This presentation is distributed in Singapore by Deutsche Bank AG, Singapore Branch. This presentation and the information contained herein is confidential and may not be reproduced or distributed in whole or in part without our prior written consent.Copyright© 2006 Deutsche Bank AG


Contact Details

Allan Levin, CFA, FSA

Head of Product DevelopmentCore Rates Structuring

Deutsche Bank AG New York60 Wall Street, 3rd FloorNew York, NY 10005

Tel. 212 250 7105 Mob. 646 [email protected]


Documents

NON TRADITIONAL ROLES FOR ACTUARIES