The Embedded Value (EV) of a life insurance company is the
present value
In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of future profits plus adjusted
net asset value
Net asset value (NAV) is the value of an entity's assets minus the value of its liabilities, often in relation to open-end, mutual funds, hedge funds, and venture capital funds. Shares of such funds registered with the U.S. Securities and Exch ...
. It is a construct from the field of
actuarial science which allows insurance companies to be valued.
Background
Life insurance
Life insurance (or life assurance, especially in the Commonwealth of Nations) is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death ...
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 outgoings comprise 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
In accounting, book 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. Tra ...
. This needs to be adjusted to
market value
Market value or OMV (Open Market Valuation) 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 the ...
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 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.
Formula
Embedded Value is calculated as follows:
:EV = PVFP + ANAV
where
:EV = Embedded Value
:PVFP =
present value
In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of future profits
:ANAV = adjusted
net asset value
Net asset value (NAV) is the value of an entity's assets minus the value of its liabilities, often in relation to open-end, mutual funds, hedge funds, and venture capital funds. Shares of such funds registered with the U.S. Securities and Exch ...
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.
References
{{Reflist
External links
Embedded value definition from Investopedia
Actuarial science