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Value and Capital Management: A Handbook for the Finance and Risk Functions of Financial Institutions

Value and Capital Management: A Handbook for the Finance and Risk Functions of Financial Institutions

Thomas C. Wilson

ISBN: 978-1-118-77462-5

Aug 2015

720 pages



A value management framework designed specifically for banking and insurance

The Value Management Handbook is a comprehensive, practical reference written specifically for bank and insurance valuation and value management. Spelling out how the finance and risk functions add value in their respective spheres, this book presents a framework for measuring – and more importantly, influencing – the value of the firm from the position of the CFO and CRO. Case studies illustrating value-enhancing initiatives are designed to help Heads of Strategy offer CEOs concrete ideas toward creating more value, and discussion of "hard" and "soft" skills put CFOs and CROs in a position to better influence strategy and operations. The challenge of financial services valuation is addressed in terms of the roles of risk and capital, and business-specific "value trees" demonstrate the source of successful value enhancement initiatives.

While most value management resources fail to adequately address the unique role of risk and capital in banks, insurance, and asset management, this book fills the gap by providing concrete, business-specific information that connects management actions and value creation, helping readers to:

  • Measure value accurately for more productive value-based management initiatives and evaluation of growth opportunities
  • Apply a quantitative, risk-adjusted value management framework reconciled with the way financial services shares are valued by the market
  • Develop a value set specific to the industry to inspire initiatives that increase the firm's value
  • Study the quantitative and qualitative management frameworks that move CFOs and CROs from measurement to management

The roles of CFO and CRO in financial firms have changed dramatically over the past decade, requiring business savvy and the ability to challenge the CEO. The Value Management Handbook provides the expert guidance that leads CFOs and CROs toward better information, better insight, and better decisions.

List of Abbreviations xiii

Preface xvii

Acknowledgments xix

About the Author xxiii

PART ONE Introduction 1

CHAPTER 1 Why is Value Management Important? 3

Better Information 3

Better Insights 6

Better Decisions 8

Why Shareholder Value? 12

CHAPTER 2 How do CFOs and CROs Add Value? 15

The Evolution of the Corporate Center as “Shareholder Surrogate” 15

The Implications for the CFO 20

The Implications for the CRO 24

PART TWO Better Information – Measuring Value 29

CHAPTER 3 RAPMs – The Industry Standard 31

What Makes Financial Services Unique? 31

What do RAPMs do and How? 34

The RAPM (R)evolution 37

Three RAPMs for Three Distinct Purposes . . . 41

. . . Linking Directly to Shareholder Value 46

Insurance Example 49

Banking Example 50

CHAPTER 4 Two Challenges in Using RAPMs 51

Do RAPMs Influence Strategy? 51

Do RAPMs Give the Right Signals? 55

CHAPTER 5 Valuing Financial Services – The Theory 71

What Determines Share Value? Market Multiples, RoE and Growth . . . 71

. . . But What Determines Market Multiples? 73

Why a Market-Consistent Approach? 77

Value: Where it Comes from and How to Create More of it 80

CHAPTER 6 Valuing Financial Services – The Evidence 85

Evidence from the Insurance Industry 85

Evidence from Banking 96

Is it Just me or are Others Thinking the Same Thing? 98

CHAPTER 7 Market-Consistent Valuation for Insurers 101

Introduction to Fair Valuation for Insurers 101

Calculating Traditional Embedded Value 104

European Embedded Value 106

Market Consistent Embedded Value (MCEV) 109

How is MCEV Calculated in Practice? 115

From MCEV to MVBS 120

Final Comments: Whither MCEV? 122

PART THREE Better Insights – Managing Value 125

CHAPTER 8 Property and Casualty Insurance 127

History and Economic Rationale 127

From Principles to Rules of the Game 133

From Rules to the Valuation of PC Businesses 135

PC KPIs: Understanding and Managing Value 140

CHAPTER 9 Life and Health Insurance 151

History and Economic Rationale 151

From Principles to “Rules of the Game” 163

LH Valuation 167

Understanding Value Creation: Capital Intensity and Financial Risk Taking 171

CHAPTER 10 Banking 189

History 189

Products 195

Economic Rationale 197

From Principles to “Rules of the Game” 199

From “Rules” to Value 201

CHAPTER 11 Achieving Profitable Growth 211

Rules of the Game and KPIs 211

Management Actions – Three Horizons of Growth 217

Horizon 1 – Increasing Sales Productivity 218

Horizon 1 – Going Multi-channel 221

Horizon 1 – Getting More out of Existing Customers; cross sell, big data and customer loyalty 224

Horizon 1 – Managing the Customer Portfolio Skew 228

Horizon 2 – Anticipating Mega-trends 230

Horizon 2 – Exploiting Adjacencies 232

Horizon 2 – Transformational and Bolt-on Acquisitions 234

Horizon 3 – Creative Disruptions 238

CHAPTER 12 Achieving Operating Efficiency 241

The Importance of Operating Efficiency 242

Rules of the Game 248

Pay Less: Optimize Procurement 249

Pay Less: From Business Process Redesign to Outsourcing 250

Use Less, But More Effectively: Digitize and Automate 253

Use Less, But More Effectively: Re-engineer the Product Portfolio 254

Use Less, But More Effectively: Managing Acquisition Expenses 257

PART FOUR Better Decisions – Capital, Balance Sheet and Risk Management 261

CHAPTER 13 Corporate Strategy and Capital Allocation 263

Corporate Strategy, Capital Allocation and Performance Management 263

Capital Allocation: The Capital Budget, from Sources to Uses of Capital 265

Capital Allocation: Optimizing the Corporate Portfolio 273

Capital Allocation: Aligning Financial Resources within Constraints 278

CHAPTER 14 Strategic Planning and Performance Management 285

What is Strategic Planning? 285

Why does Strategic Planning Fail and What can be done About it? 295

Corporate Strategy 302

CHAPTER 15 Balance Sheet Management 311

Balance Sheet Management Activities 311

The Asset/Liability Committee (ALCO) Mandate and Agenda 314

The Asset/Liability Management (ALM) Unit 323

The Insurer ALM-Investment Value Chain 330

The Treasury Function 339

CHAPTER 16 The Economics of Asset/Liability Management 345

The Role of ALM Earnings 345

The Risks: Some Spectacular ALM Failures 349

The Returns: Are Shareholders Willing to Pay a Premium or a Discount? 361

CHAPTER 17 The Practical Aspects of Asset/Liability Management 371

ALM Performance and Risk Measures 372

Calculating Funds Transfer Prices (FTPs) 385

Measuring Alpha 406

CHAPTER 18 Cash and Liquidity Management 413

Managing Funding Liquidity Risk 413

What Happens if it Goes Wrong? 416

Measuring Funding Liquidity Risk 420

CHAPTER 19 Managing the Capital and Funding Structure 431

Capital Funding Management 431

Determining the Optimal Capital Structure 436

The Empirical Reality: What Determines Capital Structure? 446

CHAPTER 20 Risk Management 451

Enterprise Risk Management 451

Taking the Right Decisions 460

The Role of Culture 463

CHAPTER 21 Risk Governance and Organization 477

Risk Governance Principles 477

Role of the Board and Management 478

Three-Line-of-Defense Model 480

The Risk Function 484

CHAPTER 22 Risk Identification and Evaluation 491

From Risk Identification to Evaluation 491

Data-Driven Approaches 497

Evaluation-Based Approaches 499

Building a Resilient Organization 507

CHAPTER 23 Risk Underwriting – Strategy and Governance 513

Underwriting Context 513

Underwriting Strategy 518

Underwriting Governance 522

CHAPTER 24 Risk Underwriting – Technical Tools 527

Retail Segment: “Scoring” Models 527

Commercial Lines: Leveraging Expert Judgment 535

Underwriting Structured Solutions 541

Underwriting Controls, Validation and Learning 542

CHAPTER 25 Risk Underwriting – From Technical Pricing to Value Maximization 549

Technical Production Cost: RAPM Pricing 549

From Technical Pricing to Optimal Price 558

CHAPTER 26 Managing Operational and Reputational Risks 571

Defining Operational Risk 571

Managing Operational Risk 581

CHAPTER 27 Risk and Limit Controlling 589

Risk Reporting 589

An Effective Risk Limit Framework 601

Final Thoughts on Risk and Limit Reporting 606


Appendix A: Market Multiple Approaches 609

Appendix B: Derivation of Steady-State Valuation Multiples 613

Appendix C: Valuing Banks and Insurers: The Link Between Value and New Business and Investment RAPM 621

Appendix D: Beyond Debt and Equity 629



Index 675