Embedded value
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The Embedded Value (EV) 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.
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[edit] Background
Life insurance 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 represents future profit.
For companies, the net asset value is usually calculated at book value. This needs to be adjusted to market values for EV purposes.
[edit] Value of the insurer
EV measures the value of the insurer by adding today's value 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.
[edit] Formula
Embedded Value is calculated as follows:
- EV = PVFP + ANAV
where
- EV = Embedded Value
- PVFP = present value of future profits
- ANAV = adjusted net asset value
[edit] Improvements
European Embedded Value (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.
[edit] References
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