Embedded value
Encyclopedia
The Embedded Value of a life insurance company is the present value
of future profits plus adjusted net asset value
. It is a construct from the field of actuarial science
which allows insurance companies to be valued.
policies are long-term contracts, where the policyholder pays a premium to be covered against a possible future event (such as the death of the policyholder).
Future income for the insurer consists of premiums paid by policyholders whilst future outgo comprises claims paid to policyholders as well as various expenses. The difference, combined with income on and release of statutory reserves, represents future profit.
Net asset value is the difference between the total assets and liabilities of an insurance company.
For companies, the net asset value is usually calculated at book value
. This needs to be adjusted to market value
s for EV purposes. Furthermore, this value may be discounted to reflect the "lock in" of some of the assets by their nature. (An example of such a lock-in would be assets held within the with-profits fund)
of the existing business (i.e. future profits) to the market value of net assets (i.e. accumulated past profits).
It is a conservative measure of the insurer's value in the sense that it only considers future profits from existing policies and so ignores the possibility that the insurer may sell new policies in future. It also excludes goodwill
. As a result the insurer is worth more than its EV.
where
(EEV) is a variation of EV which was set up by the CFO Forum which allows for a more formalised method of choosing the parameters and doing the calculations, to enable greater transparency and comparability.
Market Consistent Embedded Value is a more generalised methodology, of which EEV is one example.
Present value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...
of future profits plus adjusted net asset value
Net asset value
Net asset value is a term used to describe the value of an entity's assets less the value of its liabilities. The term is most commonly used in relation to open-ended or mutual funds because shares of such funds registered with the U.S. Securities and Exchange Commission are redeemed at their net...
. It is a construct from the field of actuarial science
Actuarial science
Actuarial science is the discipline that applies mathematical and statistical methods to assess risk in the insurance and finance industries. Actuaries are professionals who are qualified in this field through education and experience...
which allows insurance companies to be valued.
Background
Life insuranceLife insurance
Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...
policies are long-term contracts, where the policyholder pays a premium to be covered against a possible future event (such as the death of the policyholder).
Future income for the insurer consists of premiums paid by policyholders whilst future outgo comprises claims paid to policyholders as well as various expenses. The difference, combined with income on and release of statutory reserves, represents future profit.
Net asset value is the difference between the total assets and liabilities of an insurance company.
For companies, the net asset value is usually calculated at book value
Book value
In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or Impairment costs made against the asset. Traditionally, a company's book value...
. This needs to be adjusted to market value
Market value
Market value is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may differ in some...
s for EV purposes. Furthermore, this value may be discounted to reflect the "lock in" of some of the assets by their nature. (An example of such a lock-in would be assets held within the with-profits fund)
Value of the insurer
EV measures the value of the insurer by adding today's valuePresent value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...
of the existing business (i.e. future profits) to the market value of net assets (i.e. accumulated past profits).
It is a conservative measure of the insurer's value in the sense that it only considers future profits from existing policies and so ignores the possibility that the insurer may sell new policies in future. It also excludes goodwill
Goodwill (accounting)
Goodwill is an accounting concept meaning the value of an entity over and above the value of its assets. The term was originally used in accounting to express the intangible but quantifiable "prudent value" of an ongoing business beyond its assets, resulting perhaps because the reputation the firm...
. As a result the insurer is worth more than its EV.
Formula
Embedded Value is calculated as follows:- EV = PVFP + ANAV
where
- EV = Embedded Value
- PVFP = present valuePresent valuePresent value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...
of future profits - ANAV = adjusted net asset valueNet asset valueNet asset value is a term used to describe the value of an entity's assets less the value of its liabilities. The term is most commonly used in relation to open-ended or mutual funds because shares of such funds registered with the U.S. Securities and Exchange Commission are redeemed at their net...
Improvements
European Embedded ValueEuropean Embedded Value
The European Embedded Value is an effort by the CFO Forum to standardize the calculation of the Embedded value. For this purpose the CFO Forum has released guidelines how embedded value should be calculated....
(EEV) is a variation of EV which was set up by the CFO Forum which allows for a more formalised method of choosing the parameters and doing the calculations, to enable greater transparency and comparability.
Market Consistent Embedded Value is a more generalised methodology, of which EEV is one example.