J. K. Dietrich - FBE Fall, 2006 Valuation of Financial Service Firms: Insurance and Asset Management Week 3 – September 7, 2006

J. K. Dietrich - FBE Fall, 2006 Introduction to insurance industry u Assessment of financial performance performance u Application of analysis of financial information to understand reasons for performance variations u Think about valuation issues in terms of insurance application to PV-FSI

J. K. Dietrich - FBE Fall, 2006 Case Discussion: AIG u Performance u Organizational structure u Factors determining of performance u Sources of variability u Cash flows

J. K. Dietrich - FBE Fall, 2006 AIG, Torchmark, and S&P Index

J. K. Dietrich - FBE Fall, 2006 AIG, Torchmark since 9/11

J. K. Dietrich - FBE Fall, 2006 Valuation of Financial Firms u Best approach is based on discounted cash flows and, following Copeland et al, we use cash flows to equity u Spreadsheet PV-FSI is abbreviated but captures more complete models u You are free to change the spreadsheet –Add product lines (we will discuss PV-LIC this week) –Change forecast and continuing value periods

J. K. Dietrich - FBE Fall, 2006 Valuation and Projections u Dividendable cash flows correspond to cash flows to equity u Spreadsheet has two years of history and a five year explicit forecast horizon u Continuing value captured with multipliers of fifth year values –Book-to-market –Price-earnings –Value drivers approach (see Copeland et al)

J. K. Dietrich - FBE Fall, 2006 Valuation of Financial Firms u Liabilities are not just funds like debt but contractual obligations –Deposits –Insurance contracts u Dividendable cash flows to equity are: Net income + Non-cash expenses - Required equity growth u Equity must support balance sheet –Regulation –Risk

J. K. Dietrich - FBE Fall, 2006 Assumptions u Need estimates of contractual cash flows from liabilities (service costs, benefits, etc.) u Need to estimate adjustments to cash from non-cash expenses (depreciation, provision for loan losses, amortization of deferred costs) u Must assume a required equity

J. K. Dietrich - FBE Fall, 2006 Valuing Insurance Companies

J. K. Dietrich - FBE Fall, 2006 Detailed Analysis of Operations

J. K. Dietrich - FBE Fall, 2006 Ratios for Assumptions

J. K. Dietrich - FBE Fall, 2006 Valuation & Cash Flows

J. K. Dietrich - FBE Fall, 2006 For Next Week u Prepare to discuss Chapter 8 –We will discuss underlying economics of value creation in financial services –We will discuss how value is created in credit- related services discussed in Chapter 8 u Part I of project is due Thursday