The Embedded Value of a Life insurer is the present value of all future surpluses for that company, taking into account reserve releases. The company's net asset value is added to this total.
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Why?
Life insurance policies are long-term contracts, where the policyholder pays a premium for many years to be covered against an event (the death of the policyholder, for example) which may occur many years in the future. Normally, the assets of a company are what the company "owns" (like buildings, cash, stock, etc.) and liabilities are what they "owe" (to shareholders, to banks, to creditors, etc.) For an insurer, the assets could be considered to include the possible payment of future premiums for policies already sold, and the liabilities could be considered to include possible claims paid out in future, if (or indeed when) policyholders die. Embedded Value is a construct from the field of Actuarial science which allows these uncertain future cashflows to be valued, so that a more realistic picture of the company's financial position is possible, allowing for future contingencies.
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
Detail
- discounting
- risk discount rate
- net asset value
- EV earnings
Future improvements
European Embedded Value 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.
