1. April 2001 An Introduction to Life Insurance Appraisal Values

2. 2 The material that follows is a presentation of general background information about the Bank’s activities current at the date of the presentation, 3 April 2001. It is information given in summary form and does not purport to be complete. It is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any particular investor. These should be considered, with or without professional advice when deciding if an investment is appropriate. Disclaimer

3. 3 Speaker’s Notes Speaker’s notes for this presentation are attached below each slide.Speaker’s notes for this presentation are attached below each slide. To access them, you may need to save the slides in PowerPoint and view/print in “notes view.”To access them, you may need to save the slides in PowerPoint and view/print in “notes view.”

4. 4 Agenda TheoryTheory –What is an Embedded Value? –Moving from Embedded to Appraisal Value –Understanding movements in Appraisal Value –Appraisal Value ‘Uplift’ PracticePractice –Commonwealth Bank Group Appraisal Values –Appraisal Value forecasts

5. Embedded Value The present value of future profits from inforce business and the shareholders interest in the net worth of the life insurance funds

6. 6 Embedded Value No value to Shareholder Net Worth Full Value Embedded Value Balance Sheet Supporting Capital Net Worth NTA Best Estimate Policy Liability Profit Margins MoS Liability PV Capital Discounted Value PV Margins Discounted Value Net Worth Value of Inforce Business

7. 7 EV - Alternative Presentation Net Tangible Assets VIF Net Worth PV Capital PV Margins Net Worth PV Capital PV Margins Value of Inforce = PV Margins - Cost of Capital NTA as per MoS Balance Sheet

8. 8 Claims Expenses Investment Income Premium Valuation Model Inforce New Business Net Worth Shareholder Capital Dividends + Imputation Credits Capital Release Profits DCF Valuation

9. 9 Valuation Assumptions Best estimate assumptions of future experience:Best estimate assumptions of future experience: –Expenses –Claims –Persistency Economic assumptions:Economic assumptions: –Investment Income –Inflation –Risk Discount Rate Imputation CreditsImputation Credits –30% wastage Based on own and industry experience. Independent review (Trowbridge) Standard economic basis agreed with Trowbridge (RDR on CAPM methodology)

10. 10 Key Drivers of Inforce Value ‘Gap’ between net earnings rate and risk discount rate‘Gap’ between net earnings rate and risk discount rate Investment marketsInvestment markets –affects value of shareholder funds –affects value of future asset fees on investment business –policy guarantees ‘gear up’ effect of investment returns PersistencyPersistency –affects recovery of acquisition expenses or achievement of expected future margins ExpensesExpenses Mortality / MorbidityMortality / Morbidity Note changes in future assumptions have an immediate (capitalised) impact on value

11. 11 Movements in Embedded Value Net WorthInforce Earns net i‘Unwinds’ at RDR Profit & Capital Release Embedded Value New Business Capital Injection If experience is as planned... CAN WE VALUE FUTURE NEW BUSINESS?

12. Moving from Embedded Value to Appraisal Value

13. 13 Introducing the Appraisal Value Embedded ValueEmbedded Value –measures the value of the inforce business Appraisal ValueAppraisal Value –is a measure of the economic value of the business as a going concern The difference is a measure of the capacity of the company, in its existing form, to generate value by writing profitable future businessThe difference is a measure of the capacity of the company, in its existing form, to generate value by writing profitable future business … the Value of Future New Business

14. 14 Value of Future New Business - Model n Value of future NB may be presented as a multiplier of the previous year’s NB value n Multiplier reflects expected sales volumes, growth, mix and future profitability plus equals PV Expense (Overrun) / Underrun Structural Value Projected Growth Projected Margins on long term expense assumptions Sales Volumes Profit Margins Value of Future New Business X= Multiplie r Value of 1 year’s New Bus

15. 15 Value of New Business - Issues Sales volumesSales volumes –Base volumes - is latest year ‘representative’? –Market growth & own market share Profit margins - are they sustainable?Profit margins - are they sustainable? Business mix may change, involving a move to products with higher or lower marginsBusiness mix may change, involving a move to products with higher or lower margins Ability to eliminate any expense overruns ?Ability to eliminate any expense overruns ?

16. Movements in Appraisal Value

17. 17 Movement in Appraisal Value If experience is as expected: Net Worth earns net investment income, increases by profit earned on inforce business and decreases by dividend paidNet Worth earns net investment income, increases by profit earned on inforce business and decreases by dividend paid Inforce unwinds at the risk discount rate and reduces by profit earned (which becomes net worth)Inforce unwinds at the risk discount rate and reduces by profit earned (which becomes net worth) Inforce is supplemented by each year’s New BusinessInforce is supplemented by each year’s New Business Value of future New Business moves forward in line with sales growthValue of future New Business moves forward in line with sales growth We can only add further value by managing experience favourably versus assumptions, or via new initiatives

18. 18 Information Available Financial statements disclose: Shareholders net tangible assetsShareholders net tangible assets Value of inforce businessValue of inforce business Value of future new businessValue of future new business Risk Discount RatesRisk Discount Rates MoS profitsMoS profits

19. 19 Recognition of Expense Synergies Assume net savings of $10m per annum over 3 years:Assume net savings of $10m per annum over 3 years: MoS ProfitsChange in Appraisal Value Effect is spread over the life of the business Value is booked immediately Yr 1 savings Unwinding of discount rate Yr 2 savings 10 20 30 30 30 30 Yr 3 savings

20. 20 Expense Synergies Example Assume we take $20m off the expense base: Effect on MoS First full year: $20m less tax @ 30% = +$14mFirst full year: $20m less tax @ 30% = +$14m Subsequent years: $14m increases at inflation rateSubsequent years: $14m increases at inflation rate Effect on Appraisal Value Net profit $14m inflating @ f%, valued at RDR%Net profit $14m inflating @ f%, valued at RDR% Value ~ 14 / (RDR - f) say $140m Value of increase in imputation credits from the increase in future SH tax (ie. higher profit)Value of increase in imputation credits from the increase in future SH tax (ie. higher profit) Value ~ 70% x ( 6 / 14 ) x $140m = $42m

21. Appraisal Value “Uplift”

22. 22 Appraisal Value Uplift Businesses owned by life companies are held at market value (= Appraisal Value)Businesses owned by life companies are held at market value (= Appraisal Value) The “profit” earned on these businesses is the dividend received and the increase in Appraisal Value (less capital added)The “profit” earned on these businesses is the dividend received and the increase in Appraisal Value (less capital added) For clarity, the Group reports separatelyFor clarity, the Group reports separately - the accruals profit (MoS earnings) - and the balance of “profit” (AV Uplift)

23. 23 Appraisal Value Uplift The AV Uplift represents the increase in Appraisal Value in excess of the change in NTAThe AV Uplift represents the increase in Appraisal Value in excess of the change in NTA Net Profit +Capital Transfers less Dividends +Foreign Exchange Movement =Change in Shareholder NTA +Change in Value of Inforce Business =Change in Embedded Value +Change in Value of future New Business =Change in Appraisal Value AV Uplift MoS Profit

24. 24 Effect of Paying a Dividend The Appraisal Value calculation discounts distributable profits at a gross of tax discount rateThe Appraisal Value calculation discounts distributable profits at a gross of tax discount rate The AV also includes a value for any franking credits attaching to distributable profitsThe AV also includes a value for any franking credits attaching to distributable profits –valued at 70%, ie. 30% wastage assumed When dividend is paid from Life Co, the AV reduces by When dividend is paid from Life Co, the AV reduces by –the amount of the dividend –the value of attaching franking credits However, the NTA only reduces by the amount of the dividend (the franking credit being transferred directly to the parent’s f.c. account)However, the NTA only reduces by the amount of the dividend (the franking credit being transferred directly to the parent’s f.c. account) ñfranking credits are ‘lost’ from the AV Uplift

25. 25 Volatility of AV Uplift Appraisal Value is more volatile than MoS profitAppraisal Value is more volatile than MoS profit For example: Change of assumptions / Movement in interest rates –MoS ‘spreads’ the effect by adjusting future margins –Appraisal Value ‘capitalises’ the future effect => Difference (AV Uplift) will be volatile AV Uplift may also be negative, eg.AV Uplift may also be negative, eg. –adverse valuation assumptions hits AV harder than MoS profit (presuming positive future margins) –loss of franking credits on dividends hits AV but has no effect on NTA

26. April 2001 An Introduction to Life Insurance Appraisal Values