Value and capital management : a handbook for the finance and risk functions of financial institutions PDF
Preview Value and capital management : a handbook for the finance and risk functions of financial institutions
FFIRSWEB 07/01/2015 15:0:48 Page6 FFIRSWEB 07/01/2015 15:0:47 Page1 “Overthepast20years,TomWilsonhasbeenahighlyvisibleriskmanagementpractitionerin majorfinancialservicesfirms–bothbanksandinsurancecompanies–aswellasinleading advisory firms. The discussion of value management in banking and insurance in a single volume highlights that one of the major roles of financial services firms is risk-taking, risk transformation and risk management. Tom’s unique experience in both sectors has allowed him to produce a most welcome integrated handbook. Theclearexpositionthatrisk-takingandstrategicmanagementinbankingandinsurance must be integrated in a value creation framework provides invaluable tools to address managerialissuessuchasriskidentification,capitalallocation,measurementofperformance andriskgovernance.ThesharingofTomWilson’svastexperienceisagifttotheprofession.” Jean Dermine, Professor of Banking and Finance, Insead, author of Bank Valuation and Value Based Management “Much has been written on value and capital management, also for the financial services industry. But this handbook is truly different in a number of ways. First,itprovidesasolidconceptualbasistounderstandtruevaluecreationinbankingand insurance.Thismayseemacademic,butisindeedhighlyrelevantinpractice.Asalong-standing practitionerinbothindustries,Ihaveseennumeroussituationswhereprofitgenerationhasbeen mistakenforvaluecreation,oftenleadingtothewrongdecisions.Thisbookclearlydispelssome deeply embedded valuation myths in both the banking and insurance worlds, some of which arestillbeingtrainedtoday! Second, it provides a sound basis to understand and manage the value of risk-based, capitalintensivebusinessesusingacommonsetofpracticaltools,fillingavoidintheavailable literature. Third,itcoverstheentirespectrumoffinanceandriskactivitiesrelevantfortheCFOand CRO:Fromvaluationtomanagementinformationtomanagementaction.Reallifeexamples from both banking and insurance are used to illustrate the various tools in practice, be that efficiencymanagement,assetliabilitymanagement,riskmanagement,strategicplanning,and many others. I was forced to learn many of the themes covered in this handbook the hard way over several years, and I suspect the author has taken a similar journey. Much could have been easier if I had this book at hand earlier.” Jo Oechslin, CRO, Credit Suisse Group AG “Tom’sbookonriskandcapitalmanagementisthemostcomprehensiveinthefield.Itisnotonly wellstructuredandthorough,itisaneasyread.Iparticularlyenjoyedtheanecdotesthroughout givingliveexamplesininsuranceandbanking.LikemindedCROsandCFOswillalsofindthis bookcomfortinginthatitnotonlysupportstheirbeliefs,itconveystheyarenotaloneintryingto get the fundamental point of true value measurement accepted and embedded in their own organizations.LastlyIwantedtocomplimentTomonhisdescriptionoftherolesoftheCFOand CROinfinancialinstitutions.IhavetoooftenheardthatCROsmustremainfullyindependentof businessdecisionsonlybeingabletoblowawhistlewhenthereisaproblem.Thebookclearly pointstotheCROasavitalpartofmanagementdecisionmakingfromstrategytoexecutionand thatCROsmustremainobjective,leavingindependencetoauditandsupervisors.” Tom Grondin, CRO, Aegon Insurance FFIRSWEB 07/01/2015 15:0:47 Page2 “The rolesof CFOs andCROs in financial serviceshave gone throughan enormous transfor- mation over the past decade, driven by external factors such as increasing shareholder and regulatoryexpectationsandtheglobalfinancialcrisis,aswellasbythemanagements’interestin fundamentallyimprovinghowtheymanagevalueandcapital.Tom’sbookoffersinsightsatthe nexus of aligning risk management, finance and performance management to boost the firm’s value.Avastpieceofworkprovidingacompellingsetoftoolstounderstandtheindiscerniblelink between risk and financial metrics and actually using them to better manage the firm.” Axel P. Lehmann, Zurich Insurance Group Ltd “The financial services industry still has a surprisingly long way to go to understand and communicatehowitmanagesriskandcreatesvalue.Itisrefreshingtoreadadefenceofvalue creation for the shareholder being consistent with running a business for the benefit of all stakeholders.IalsowelcomeinsightsintohowCFOsandCROscandemonstrateandquantify theircontributiontothisvaluecreationandreversetheconglomeratediscountthatmanylarge groups suffer from. Tom Wilson offers useful insights based on financial theory and his respected experience as a senior executive.” William Hawkins, Managing Director – Head of European Insurance Research, Keefe, Bruyette & Woods “Tom Wilson expertly brings to bear his unique perspective of financial services providers’ valueandcapitalmanagementpracticesinthisbook.IhaveencounteredTomservingasrisk managerandrisktakerin,andadvisorto,manyoftheworld’sleadinglifeinsurers,property casualty insurers, reinsurers, banks and asset managers. His book mixes theory with the evolution of practice across the sector, and draws on many real life examples. I commend Tom’s work to all practitioners in, and observers and students of, financial services.” Rob Jones, Former Managing Director at Standard & Poor’s Financial Services Ratings FFIRSWEB 07/01/2015 15:0:48 Page3 Value and Capital Management A Handbook for the Finance and Risk Functions of Financial Institutions THOMAS C. WILSON FFIRSWEB 07/01/2015 15:0:48 Page4 Thiseditionfirstpublished2015 2015JohnWiley&SonsLtd Registeredoffice JohnWiley&SonsLtd,TheAtrium,SouthernGate,Chichester,WestSussex,PO198SQ,UnitedKingdom. Fordetailsofourglobaleditorialoffices,forcustomerservicesandforinformationabouthowtoapplyfor permissiontoreusethecopyrightmaterialinthisbookpleaseseeourwebsiteatwww.wiley.com. Allrightsreserved.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmitted, inanyformorbyanymeans,electronic,mechanical,photocopying,recordingorotherwise,exceptas permittedbytheUKCopyright,DesignsandPatentsAct1988,withoutthepriorpermissionofthepublisher. Wileypublishesinavarietyofprintandelectronicformatsandbyprint-on-demand.Somematerialincluded withstandardprintversionsofthisbookmaynotbeincludedine-booksorinprint-on-demand.Ifthisbook referstomediasuchasaCDorDVDthatisnotincludedintheversionyoupurchased,youmaydownloadthis materialathttp://booksupport.wiley.com.FormoreinformationaboutWileyproducts,visitwww.wiley.com. Designationsusedbycompaniestodistinguishtheirproductsareoftenclaimedastrademarks.Allbrand namesandproductnamesusedinthisbookaretradenames,servicemarks,trademarksorregistered trademarksoftheirrespectiveowners.Thepublisherisnotassociatedwithanyproductorvendormentionedin thisbook. LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheirbesteffortsin preparingthisbook,theymakenorepresentationsorwarrantieswiththerespecttotheaccuracyorcompleteness ofthecontentsofthisbookandspecificallydisclaimanyimpliedwarrantiesofmerchantabilityorfitnessfora particularpurpose.Itissoldontheunderstandingthatthepublisherisnotengagedinrenderingprofessional servicesandneitherthepublishernortheauthorshallbeliablefordamagesarisingherefrom.Ifprofessional adviceorotherexpertassistanceisrequired,theservicesofacompetentprofessionalshouldbesought. LibraryofCongressCataloging-in-PublicationData Wilson,ThomasC., Valueandcapitalmanagement:ahandbookforthefinanceandriskfunctionsoffinancialinstitutions/ ThomasC.Wilson.—1 pagescm.—(TheWileyfinanceseries) Includesbibliographicalreferencesandindex. ISBN978-1-118-77463-2(hardback) 1. Banksandbanking. 2. Financialservicesindustry. 3. Riskmanagement. I. Title. HG1601.W5582015 332.1068´1—dc23 2015013221 AcataloguerecordforthisbookisavailablefromtheBritishLibrary. ISBN978-1-118-77463-2(hardback) ISBN978-1-118-77438-0(ebk) ISBN978-1-118-77462-5(ebk) ISBN978-1-118-77435-9(obk) CoverDesign:Wiley CoverImage:IaroslavNeliubov/Shutterstock Setin10/12ptTimesLTStd-RomanbyThomsonDigital,Noida,India PrintedinGreatBritainbyTJInternationalLtd,Padstow,Cornwall,UK FFIRSWEB 07/01/2015 15:0:48 Page5 To Kurt and Arlyn, with love and gratitude FFIRSWEB 07/01/2015 15:0:48 Page6 FTOCWEB 07/01/2015 14:46:34 Pagevii Contents ListofAbbreviations xiii Preface xvii Acknowledgments xix AbouttheAuthor xxiii PARTONE Introduction 1 CHAPTER1 WhyisValueManagementImportant? 3 BetterInformation 3 BetterInsights 6 BetterDecisions 8 WhyShareholderValue? 12 CHAPTER2 HowdoCFOsandCROsAddValue? 15 TheEvolutionoftheCorporateCenteras“ShareholderSurrogate” 15 TheImplicationsfortheCFO 20 TheImplicationsfortheCRO 24 PARTTWO BetterInformation–MeasuringValue 29 CHAPTER3 RAPMs–TheIndustryStandard 31 WhatMakesFinancialServicesUnique? 31 WhatdoRAPMsdoandHow? 34 TheRAPM(R)evolution 37 ThreeRAPMsforThreeDistinctPurposes . . . 41 . . . LinkingDirectlytoShareholderValue 46 vii FTOCWEB 07/01/2015 14:46:34 Pageviii viii CONTENTS InsuranceExample 49 BankingExample 50 CHAPTER4 TwoChallengesinUsingRAPMs 51 DoRAPMsInfluenceStrategy? 51 DoRAPMsGivetheRightSignals? 55 CHAPTER5 ValuingFinancialServices–TheTheory 71 WhatDeterminesShareValue?MarketMultiples, RoEandGrowth . . . 71 . . . ButWhatDeterminesMarketMultiples? 73 WhyaMarket-ConsistentApproach? 77 Value:WhereitComesfromandHowtoCreateMoreofit 80 CHAPTER6 ValuingFinancialServices–TheEvidence 85 EvidencefromtheInsuranceIndustry 85 EvidencefromBanking 96 IsitJustmeorareOthersThinkingtheSameThing? 98 CHAPTER7 Market-ConsistentValuationforInsurers 101 IntroductiontoFairValuationforInsurers 101 CalculatingTraditionalEmbeddedValue 104 EuropeanEmbeddedValue 106 MarketConsistentEmbeddedValue(MCEV) 109 HowisMCEVCalculatedinPractice? 115 FromMCEVtoMVBS 120 FinalComments:WhitherMCEV? 122 PARTTHREE BetterInsights–ManagingValue 125 CHAPTER8 PropertyandCasualtyInsurance 127 HistoryandEconomicRationale 127 FromPrinciplestoRulesoftheGame 133 FromRulestotheValuationofPCBusinesses 135 PCKPIs:UnderstandingandManagingValue 140 CHAPTER9 LifeandHealthInsurance 151 HistoryandEconomicRationale 151 FromPrinciplesto“RulesoftheGame” 163
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