EMBEDDED VALUE FOR ACTUARIES : CHAPTER 2

History of Embedded Value?

The history of EV dates back to 1980s, when companies in UK started to disclose to EV. In 2001, the Association of British Insurers (ABI) developed guidelines for the calculation of EV.??EV calculated using these guidelines was referred to as the “achieved profits method” (APM)

In 2004, the CFO Forum (a discussion group composed of the CFOs of the major European insurance companies) issued a paper titled European Embedded Value Principles (EEV Principles). EV as typically calculated prior the publication of this paper is called “Traditional Embedded Value” (TEV). This is generally consistent with APM.

In June 2008, the CFO Forum published Market Consistent Embedded Value Principles

Current MCEV is calculated using these principles

Major advantages of MCEV compared to TEV and EEV??

Both MCEV and EEV differs from TEV in the reflection of the values of embedded options and guarantees.

MCEV is calculated using risk neutral, market consistent economic assumptions

MCEV was introduced as a replacement of EEV mainly to address criticisms that company-specific assumptions were used by EEV, so the results were largely un-comparable across companies

Additionally, MCEV provided a means of calculating the value of options and guarantees within long term insurance contracts.

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?What MCEV is used for ?

This point was discussed in chapter 1 as well. MCEV result is used as a tool for

• Justification of stock prices
• Incentive analysis for senior executives
• Analysis of business profitability and Capital Requirement
• Evaluation of M&A (mergers and acquisitions) activities
• Use of rating agencies for the evaluation of the financial performance of a life insurance company?

?What is the relationship between MCEV and actuarial appraisal value??

Actuarial appraisal method is similar to EV as it is calculated using similar concepts (discounted cash-flow approach)

However, appraisal value typically includes the value of future sales, whereas MCEV does not (MCEV includes current new business but excludes future new business)

MCEV uses company-specific non-economic assumptions (expense, mortality, withdrawals etc.) whereas appraisal value uses a mixture of industry-wide and company-specific assumptions

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