Swiss Re - EVM - slides 2006

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Swiss Re - EVM - slides 2006

  1. 1. ab Economic Value Management (EVM) Teach-in 31 March 2008 ab Today’s agenda Welcome and introduction Susan Holliday EVM methodology EVM figures From Embedded Value to EVM Summary Questions & answersEVM Teach-in31 March 2008Slide 2
  2. 2. ab Today’s agenda Welcome and introduction EVM methodology George Quinn EVM figures From Embedded Value to EVM Summary Questions & answersEVM Teach-in31 March 2008Slide 3 EVM methodology ab Economic steering at Swiss Re Economic Value Management (EVM) is Swiss Re’s integrated economic measurement and steering framework used for planning, pricing, reserving and managing the business Consistency throughout the Target performance cycle: setting Strategy Planning Target setting/planning/ pricing/reserving All measurements used Capital allocation/capital throughout the performance budgeting cycle are based on EVM methodology Performance Performance measurement/ Pricing compensation measurementEVM Teach-in Tracking31 March 2008 renewalsSlide 4
  3. 3. EVM methodology EVM results are meant to respond ab to three basic questions: Are our underwriting activities creating economic value on a stand- alone basis? Are our investment activities creating economic value after risk adjustments? Can we assess different underwriting and investment opportunities on a like for like basis? EVM profit is the common measure of economic value creation that guides steering decisionsEVM Teach-in31 March 2008Slide 5 EVM methodology To answer these three questions, ab the EVM framework… Splits performance of fund raising activities (underwriting) and fund investment activities (asset management) Recognises all profits on new business at inception, changes in estimates as they occur, and excludes future new business Values assets and liabilities on a market consistent basis Reflects best estimates Measures performance after capital costs (i.e. cost to shareholders of taking risk)EVM Teach-in31 March 2008 The following slides illustrate how theseSlide 6 principles apply in EVM ...
  4. 4. EVM methodology Separation of underwriting and ab investment activitiesSeparation ofunderwriting and Splits performance of fund raising activities (underwriting) and fundinvestment investment activities (asset management)activities in linewith basic financial Overall economiceconomics balance sheetprinciples Economic Market liabilities value assets Economic Asset management net worth Underwriting balance sheet balance sheet Replicating Replicating Economic Market portfolio Asset management pays portfolio liabilities value underwriting risk-free assets returns for the funds that Economic are raised net worthEVM Teach-in31 March 2008 - Investment decisions - Underwriting decisions - Management ofSlide 7 existing business EVM methodology ab Replicating reinsurance liabilities Replicating portfolios Expenses, taxes, and Underlying business cash frictional costs flows The replicating portfolio provides the cash flows needed to meet expected future payments Cash flow years 1 2 3 4 5 The choice of replicating instruments Discount depends on the financial market risk back at risk exposure embedded in the liabilities free rate A simple example: Discounted economic cash flows Expected mortality claims payments (equals market value of replicating portfolio) in 5 years can be replicated by a 5 year zero-coupon bond with the same maturity and payout Net Economic The market value of the bond today replicating = value of equals the economic value of theEVM Teach-in portfolio liabilities expected claims payments31 March 2008Slide 8 Market value of replicating portfolio = Economic value of liabilities
  5. 5. EVM methodology ab Measurement of underwriting activities A standard replication example (I/III)Example Recognises all profits on new business at inceptionEVM calculation Measurement CHF thousands Inception Year 1 Year 2 Year 3for a simple fire at inceptionrisk XL contract at Premiumsinception Claims Expenses New business value Taxes creation at day 1 Capital costs Undiscounted Expected cash flows 2 600 -1 000 -700 -700 EVM profit 300 Premium received at 2% inception Production 2.25% 2 600 costEVM Teach-in -2 300 2.5%31 March 2008Slide 9 EVM methodology ab Measurement of underwriting activities A standard replication example (II/III)Example Measurement is based on market prices and best estimatesEVM calculation Measurement CHF thousands Inception Year 1 Year 2 Year 3for a simple fire at inceptionrisk XL contract at Premiumsinception Claims Expenses New business value Taxes creation at day 1 Capital costs Undiscounted Expected cash flows 2 600 -1 000 -700 -700 EVM profit 300 Premium received at 2% inception Production 2.25% 2 600 costEVM Teach-in -2 300 2.5%31 March 2008Slide 10 Transfer price of funds (TPF) = risk free rates at inception
  6. 6. EVM methodology ab Measurement of underwriting activities A standard replication example (III/III)Example Measures performance after capital costs (includes a projection of capital costs)EVM calculation Measurement CHF thousands Inception Year 1 Year 2 Year 3for a simple fire at inceptionrisk XL contract at Premiumsinception Claims Expenses New business value Taxes creation at day 1 Capital costs Undiscounted Expected cash flows 2 600 -1 000 -700 -700 EVM profit 300 Capital costs Premium -90 received at 2% inception Production 2.25% 2 600 costEVM Teach-in -2 300 2.5%31 March 2008Slide 11 EVM methodology ab Measurement of underwriting activities Insufficient premium incomeExample A contract that generates an EVM loss at inception should be declinedEVM calculation EUR thousands Inception Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7for a ContinentalEuropean Premiumsproportionalmotor contract at Claimsinception Expenses Taxes New business loss Capital costs at day 1 Future exp. cash flows 1 870 -443 -482 -410 -349 -278 -214 -45 EVM loss: -60 4% 4.25% Premium Production 4.5% received at cost 4.75% inception -1 930 4.9% 1 870EVM Teach-in 4.9%31 March 2008 5.1%Slide 12
  7. 7. EVM methodology ab Illustration Did underwriting activities generate economic profit? CHF thousands New business profit after capital costs 300 PV of premiums 2 600 PV of claims -1 840 PV of commissions -110 EVM value of new business PV of expenses -110 PV of taxes -150 PV of capital costs -90 Previous business profit after capital costs 59 Change in premiums 60 Change in claims 20 Change in EVM value of Change in commissions -5 Change in expenses -4 previous years business Change in taxes -8 Change in capital costs -4 Total profit 359 Release of capital costs and Release of capital costs 100 risk-free return on shareholders’ funds Income before capital costs 459 EVM Teach-in EVM profit is defined as total return generated for shareholders after 31 March 2008 allowing for capital costs. An EVM profit of zero means that all production Slide 13 costs including the cost of capital are covered EVM methodology ab Measurement of underwriting activities Focus on profit recognition in EVM EVM B/S TPF at T0 EVM recognises all profits at inception based on the present value of all future expected cash flows Market value of Economic repl. liabilities Subsequent experience variances are recognised as previous years portfolio development EVM previous years results are calculated as the present value ofAn upward shift of the yieldcurve has a symmetrical the difference between previous and revised cash flow estimatesimpact on both sides of theunderwriting balancesheet: Total EVM profit is the sum of new business and previous years profit EVM B/S TPF at T1 Market Changes in interest rates do not affect the underwriting result on value of Economic repl. liabilities the in-force book, as the projected cash flows are matched by the portfolio risk free replicating portfolio EVM Teach-in 31 March 2008 Slide 14
  8. 8. EVM methodology ab Investment performance in EVM Interest rates affect EVM Overall economic investment results only if balance sheet the actual investment portfolio does not fully Economic Market liabilities match the replicating value portfolio and economic net assets worth Economic Asset management net worth Underwriting In case of a full asset balance sheet balance sheet liability match, changes in interest rates have Replicating Replicating Economic Market portfolio portfolio liabilities symmetrical effects on both value sides of the balance sheet assets Economic no change in economic net worth net worth The EVM investment result depends on the actual investment mix compared with the benchmarkEVM Teach-in portfolio31 March 2008Slide 15 EVM methodology ab Investment activities Performance calculation in EVM Mark-to- Cost of Tax, fx, EVM income Capital EVM profit market funds expenses before capital costs after capital investment costs costs return Benchmark returnEVM Teach-in (return on minimum31 March 2008 risk portfolio)Slide 16
  9. 9. EVM methodology ab Example 1 Full ALM match and interest rates go down Assumption: Actual investment portfolio (consisting of risk-free bonds) matches benchmark in terms of currency structure and duration Scenario: Parallel decrease of global interest rates of 100bps Balance sheet is largely immunised against changes in interest rates CHF bn 4.0 -4.0 0 0 0 0 Mark-to- Cost of Tax, fx, EVM income Capital EVM profit market funds expenses before costs after capital investment capital costs costsEVM Teach-in return31 March 2008Slide 17 EVM methodology ab Example 2 Long duration position and interest rates go down Assumption: Actual investment portfolio (consisting of risk free bonds) has a longer duration than the benchmark. The balance sheet is exposed to interest rate risk Scenario: Parallel decrease of global interest rates of 100bps Swiss Re’s actual investment portfolio outperforms the benchmark CHF bn -4.0 -0.2 5.0 0.8 -0.1 0.7 Mark-to- Cost of Tax, fx, EVM income Capital EVM profit market funds expenses before costs after capital investment capital costs costsEVM Teach-in return31 March 2008Slide 18
  10. 10. EVM methodology ab Example 3 Investment in corporate bonds and spreads widen Assumption: Actual investment portfolio (consisting US AAA-rated corporate bonds) underperforms the benchmark (credit spreads widen). The balance sheet is exposed to credit risk Scenario: Total return of corporate bond portfolio: 1.3% CHF bn 1.8 -4.0 0.3 -1.9 -0.2 -2.1EVM Teach-in Mark-to- Cost of Tax credit, fx, EVM income Capital EVM loss31 March 2008 market funds expenses before costs after capitalSlide 19 investment capital costs costs return EVM methodology ab Example 4 Assets partially invested in equities Assumption: Actual investment portfolio consists of 8% equities (S&P 500 index) and 92% risk-free bonds. The balance sheet is exposed to equity risk Scenario: S&P 500 annual total index return: 15.8% Swiss Re’s actual investment portfolio outperforms the benchmark CHF bn -4.0 -0.4 5.4 1.0 -0.5 0.5 Mark-to- Cost of Tax, fx, EVM income Capital EVM profit market funds expenses before capital costs after capital investment costs costsEVM Teach-in return31 March 2008Slide 20
  11. 11. EVM methodology ab Capital costs in EVM EVM capital costs consist of: 1. Risk free return on capital representing shareholders base cost of capital 2. Market risk premium (MRP) representing the shareholders’ expected excess returns on market risk exposure, applicable to all business activities that generate systematic Total required market risk return on capital 3. Frictional capital costs (FCC) representing shareholders required compensation for agency costs, cost of potential financial distress and regulatory/illiquidity costsEVM Teach-in31 March 2008Slide 21 EVM methodology ab EVM and market consistent embedded value (MCEV) have significant commonalities EV EVM MCEV Market consistent ✘ ✔ ✔ Separate presentation of assets and liabilities ✘ ✔ ✘ Explicit charges for capital costs and credit risk ✘ ✔ ✔ Applicable to all products ✘ ✔ ✔EVM Teach-in31 March 2008Slide 22
  12. 12. ab Today’s agenda Welcome and introduction EVM methodology EVM figures George Quinn From Embedded Value to EVM Summary Questions & answersEVM Teach-in31 March 2008Slide 23 EVM figures ab EVM 2006 income statement by business unit Property & Life & Financial GroupCHF m Casualty Health Markets items TotalProfitNew business profit 1 695 391 995 -71 3 010Previous years business profit 137 328 0 225 690Total profit after capital costs 1 832 719 995 154 3 700Release of capital costs 1 578 1 007 857 99 3 541Income before capital costs 3 410 1 726 1 852 253 7 241 EVM 2006 is unaudited The EVM production process is not subject to the same control environment as annualEVM Teach-in and quarterly US GAAP reporting31 March 2008Slide 24
  13. 13. EVM figures ab Drivers of 2006 EVM results Property & Casualty – New business profit CHF 1 695m, driven by low natural catastrophe losses and improving pricing, terms and conditions – Previous years business profit CHF 137m, reflecting moderate net positive claims development Life & Health – New business profit CHF 391m, driven by GE Life UK transaction and improved margins on traditional – Previous years business profit of CHF 328m reflecting positive experience variances and claims projections due to favourable mortality and morbidity developments Financial Markets – Total EVM profit CHF 995m, driven by strong returns in fixed income, equities and alternative investments Group items – Total EVM profit CHF 154m, mainly driven by favourable pension fund performance and improved diversification leading to lower frictional capital costs Insurance SolutionsEVM Teach-in31 March 2008 – The Insurance Solutions acquisition was accounted for as a 2006 balance sheet transaction that added CHF 1.9bn to economic net worthSlide 25 EVM figures ab EVM 2006 investment result EVM 2006 investment result of Financial Markets CHF bn -4.0 -0.4 6.2 1.8 -0.8 1.0 Mark-to- Cost of Tax, fx, EVM income Capital EVM profit market funds expenses before costs after capital investment capital costs costs returnEVM Teach-in31 March 2008Slide 26
  14. 14. EVM figures ab 2006 Group economic net worth Group economic net worth (ENW) is the difference between the Overall economic market value of assets and the economic value of liabilities balance sheet ENW is the EVM estimate of shareholders’ funds Economic Market liabilities At 31 December 2006, ENW was CHF 39.2 billion value assets Economic net worth CHF bn 39.2 30.9EVM Teach-in US GAAP shareholders equity EVM economic net worth31 March 2008Slide 27 EVM figures ab EVM 2006 capital by business unit Property & Life & Financial Group CHF m Casualty Health Markets items Total EVM capital (average) 18 104 12 183 4 381 219 34 887 EVM capital is the measure of capital that is required to support the business EVM capital is projected until the business runs off, and serves as the basis for the allocation of capital costs EVM capital takes internal risk, regulatory and rating agency capital requirements into considerationEVM Teach-in31 March 2008Slide 28 Figures reflect the new reporting structure introduced for 2007 GAAP reporting
  15. 15. ab Today’s agenda Welcome and introduction EVM methodology EVM figures From Embedded Value to EVM George Quinn Summary Questions & answersEVM Teach-in31 March 2008Slide 29 From Embedded Value to EVM ab EV to EVM – different presentation & terminology EV EV - alternative presentation EVM Assets Embedded Value Economic Marked to backing Statutory liabilities liabilities market statutory liabilities Market Market liabilities value value EV required CoC assets Embedded assets Economic Market capital Value net worth value Excess NW Embedded Value VIF Consider these Re-present components separately Embedded Statutory Value liabilities liabilities Net these componentsEVM Teach-in VIF off against each other31 March 2008 CoCSlide 30
  16. 16. From Embedded Value to EVM ab EV to EVM – “Balance Sheet walk” (I/III) Swiss Re’s Life & Health portfolio under EV and EVM is compared below (values as at 31 December 2006) Step 1: Re-present EV results in EVM format (per before) No change in value from this step EV EV - alternative presentation Assets Embedded backing Statutory Value Marked- statutory liabilities Market liabilities to-market liabilities value assets Embedded EV required CoC CHF 22.6bn capital Value Excess NW Embedded Value VIF CHF 22.6bnEVM Teach-in31 March 2008Slide 31 From Embedded Value to EVM ab EV to EVM – “Balance Sheet walk” (II/III) Step 2: Adjust assets and capital allocated under EV to be consistent with the allocation of assets and capital to the insurance operation under EVM (= replicating portfolio + EVM capital) This step only represents a change in notionally allocated assets, i.e. no “real” value created/destroyed in this step EV (EV asset allocation) EV ’ (EVM asset allocation) Embedded Embedded Market Value Value Market value liabilities liabilities value assets assets (EVM basis) Adj Embedded Value CHF 12.2bn (EV basis) Embedded Value CHF 22.6bnEVM Teach-in31 March 2008 Change in notional asset allocationSlide 32
  17. 17. From Embedded Value to EVM ab EV to EVM – “Balance Sheet walk” (III/III) Step 3: Remaining measurement differences reflect the aggregate impact of the different EV & EVM methodologies across the total Life & Health portfolio (as at 31 December 2006) EV ’ (EVM asset allocation) EVM Embedded Economic Market Value Market liabilities value liabilities value assets assets Adj Embedded Allocated (EVM basis) (EVM basis) Value CHF 12.2bn economic CHF 12.2bn net worth 1) Although the overall adjusted EV and EVM are similar, there may be substantial differences between sublines and territoriesEVM Teach-in31 March 2008Slide 33 1) Equal to L&H EVM capital From Embedded Value to EVM ab Life & Health EV to EVM – 2006 earningsNew business profit 2006 (CHF m) EV EVMis higher under EV New business profit 664 478due to projection of Previous business profitinvestment income Operating assumption changes 409 377on higher yieldingassets Experience variances -35 -40 Profit after capital costs 1 038 815 Expected return on in-force 1 116 Expected return on ANW 336 Investment variances -35 Economic assumption changes -88 EVM capital costs 995 Corporate centre expense allocations in EVM but not EV -84 EV earnings/EVM income before capital costs 2 367 1 726EVM Teach-in31 March 2008 Main differences are capital allocation, capital costs, and assumedSlide 34 investment returns (details see appendix)
  18. 18. ab Today’s agenda Welcome and introduction EVM methodology EVM figures From Embedded Value to EVM Summary George Quinn Questions & answersEVM Teach-in31 March 2008Slide 35 Summary ab Summary and outlook EVM is Swiss Re’s internal economic framework for performance measurement and steering EVM allows comparison of performance across all lines of business EVM framework: – Splits performance of investment and underwriting activities – Recognises all closed book profits at inception (excludes franchise value) – Values all assets and liabilities in a market consistent way – Reflects current best estimates – Measures performance after allowing for capital costs 2006 Group economic net worth CHF 39.2 billion, 2006 EVM income before capital costs CHF 7.2 billion, EVM profit after capital costs CHF 3.7 billionEVM Teach-in31 March 2008 2007 EVM figures will be disclosed with Q1 2008 results onSlide 36 6 May 2008
  19. 19. ab Today’s agenda Welcome and introduction EVM methodology EVM figures From Embedded Value to EVM Summary Questions & answers George Quinn/John BaxterEVM Teach-in31 March 2008Slide 37 ab AppendixEVM Teach-in31 March 2008Slide 38
  20. 20. EVM methodology ab EVM definition of new business General principle EVM recognises all expected cash flows from contractual obligations at inception. Deferral and fund methods of accounting are not used. In any calendar year, new business is defined as business with an inception date within the calendar year P&C Insurance or reinsurance contracts written or renewed within the calendar year are recognised as new business. This also applies to multi-year transactions. Future renewals are not included in the valuation Life & Health New business includes: new individual business cessions in the year, renewals of existing group schemes, increments to existing group schemes, new group schemes, new blocks of Admin Re business and new cessions in the year on any Admin Re blocks still open to new business, and renewals of business that is subject to active annual renewalEVM Teach-in Financial Markets31 March 2008 All investment and trading activities are marked-to-market and recognised as newSlide 39 business EVM figures ab US GAAP vs. economic balance sheet Group GAAP balance sheet Group economic balance sheet Business Investment liabilities assets Investment Business Value assets liabilities above B/S Other Business liabilities assets GAAP equity Other assets Business Other liabilities assets ENW Other assetsEVM Teach-in31 March 2008Slide 40
  21. 21. EVM figures ab EVM discount rates The risk-free discount rates that are used to value insurance contracts are called transfer price of funds (TPF) rates TPF rates are based on Libor swap spot rates, reported for 25 currencies and 50 years on a monthly basis A charge is deducted from Libor swap spot rates for all currencies and durations, to reflect credit risk in Libor swap marketsEVM Teach-in31 March 2008Slide 41 From Embedded Value to EVM ab EV & EVM Balance sheet item EV EVMAssets Investment assets covering Marked-to-market allowance as Market value statutory liabilities part of VIF-calculation Investment assets covering net Market value Market value worth Premiums and fees receivable Discounted at risk discount rate Discounted at risk free rate (RDR) Retrocession assets Discounted at RDR (allowance Discounted at risk free rate, for credit risk implied in RDR) with explicit allowance for counterparty credit risk (CDS spreads)Liabilities Claims and benefits payable Discounted at RDR Discounted at risk free rate Future maintenance expenses Discounted at RDR Discounted at risk free rate Future tax payments Discounted at RDR Discounted at risk free rate Options and guarantees Stochastic models Stochastic modelsEVM Teach-in31 March 2008Slide 42
  22. 22. From Embedded Value to EVM ab EV & EVM Balance sheet item EV EVMCapital cost Financial market risk premiums Implied in RDR Explicit market risk premiumscharges reflecting financial market risk Risk capital costs Implied in RDR Explicit charge of 4% on ENW Costs associated with PV of spread between RDR and for frictions related to the cost conservatism in regulatory investment yield on assets of financial distress, agency reserves supporting margins in costs and liquidity costs from regulatory reserves regulatory requirements Cost of holding additional PV of spread between RDR and capital required to meet investment yield on assets regulatory/rating agency supporting required capital requirementsTax on Allowed for implicitly The tax on the investmentinvestment income on economic net worthincome on is an explicit charge in the EVMcapital profit calculation. Embedded value Shareholders funds (Net Worth) Required capital less Cost of Group economic net worth is (EV) or economic Capital plus valuation market value of assets lessEVM Teach-in net worth (EVM)31 March 2008 differences between regulatory market value of liabilities and and EV values (VIF) plus surplus capital cost provisionsSlide 43 capital in L&H entities From Embedded Value to EVM ab EV & EVM – comparison of terminology used Key measures EV EVM Return-on-capital Internal rate of return (IRR) Economic return on capital (EROC) = EVM net income / economic net worth Shareholder net worth Embedded Value (EV) Economic net worth Value added by new Value added by new business EVM profit on new business business Value added by inforce Operating assumption changes EVM profit on previous years’ business business Experience variancesEVM Teach-in31 March 2008Slide 44
  23. 23. ab Corporate calendar & contacts Corporate calendar 18 April 2008 144th Ordinary Annual General Meeting (Zurich) 06 May 2008 First Quarter 2008 Results and 2007 EVM (Conf. Call) 05 August 2008 Second Quarter 2008 Results (Conference Call) 08 September 2008 Investors’ meeting (Monte Carlo) 25 September 2008 Investors’ day (Zurich) 06 November 2008 Third Quarter 2008 Results (Conference Call) Investor Relations contact Hotline +41 43 285 4444 Susan Holliday +44 20 7933 3890 Andreas Leu +41 43 285 5603 Marc Habermacher +41 43 285 2637 Chris Menth +41 43 285 3878EVM Teach-in31 March 2008 E-mail Investor_Relations@swissre.comSlide 45 Cautionary note on ab forward-looking statementsCertain statements and illustrations contained herein are forward-looking. These statements and illustrations provide current expectations of future events based oncertain assumptions and include any statement that does not directly relate to a historical fact or current fact. Forward-looking statements typically are identified bywords or phrases such as "anticipate", "assume", "believe", "continue", "estimate", "expect", "foresee", "intend", "may increase" and "may fluctuate" and similarexpressions or by future or conditional verbs such as "will", "should", "would" and "could". These forward-looking statements involve known and unknown risks,uncertainties and other factors, which may cause Swiss Res actual results, performance, achievements or prospects to be materially different from any future results,performance, achievements or prospects expressed or implied by such statements. Such factors include, among others: changes in global economic conditions and the risk of a global economic mortality and morbidity experience; downturn; policy renewal and lapse rates; direct and indirect impact of continuing deterioration in the credit markets, and changes in rating agency policies or practices; further adverse rating actions by credit rating agencies in respect of structured the lowering or loss of one of the financial or claims-paying ratings of one or credit products or other credit-related exposures and of monoline insurance more of our subsidiaries; companies; political risks in the countries in which we operate or in which we insure risks; the occurrence of other unanticipated market developments or trends; extraordinary events affecting our clients and other counterparties, such as the ability to maintain sufficient liquidity and access to capital markets; bankruptcies, liquidations and other credit-related events; the cyclicality of the reinsurance industry; risks associated with implementing our business strategies; uncertainties in estimating reserves; the impact of current, pending and future legislation, regulation and regulatory the effect of market conditions, including the global equity and credit markets, and legal actions; and the level and volatility of equity prices, interest rates, currency values and the impact of significant investments, acquisitions or dispositions, and any other market indices ; delays, unexpected costs or other issues experienced in connection with any expected changes in our investment results as a result of the changed such transactions, including, in the case of acquisitions, issues arising in composition of our investment assets or changes in our investment policy; connection with integrating acquired operations; the frequency, severity and development of insured claim events; changing levels of competition; and acts of terrorism and acts of war; operational factors, including the efficacy of risk management and other internal procedures in managing the foregoing risks.EVM Teach-in not exhaustive. We operate in a continually changing environment and new risks emerge continually. Readers are cautioned not to place undue relianceThese factors areon forward-looking statements. We undertake no obligation to publicly revise or update any forward-looking statements, whether as a result of new information, future31 March 2008events or otherwise.Slide 46

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