Value and capital management : a handbook for the finance and risk functions of financial institutions

723 Pages·2015·40.71 MB·English

by  Thomas C. Wilson

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“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
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“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
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Value and Capital
Management
A Handbook for the Finance and Risk
Functions of Financial Institutions
THOMAS C. WILSON
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Thiseditionfirstpublished2015
2015JohnWiley&SonsLtd
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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
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To Kurt and Arlyn, with love and gratitude
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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
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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