An Introduction to Embedded
Value
Peter Erlandsen, CFO, Manulife
Rio Winardi, Chief Actuary, Astra CMG
Simon, Chief Accountant, Panin life
Date: 8 December, 2005
AGENDA
I.
II.
III.
IV.
V.
VI.
VII.
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Why Calculate Embedded Value?
What is Embedded Value?
Net Worth
Value of In-Force
Value of new business
Other Issues
Question & Answer
I. Why Calculate Embedded Value
An Introduction
•
Embedded Value Estimates Value.
•
Quiz 1 - What Does Profit Measure?
•
•
Quiz 2 – Why is Profit not a measure of Value?
•
•
•
Profit is a measure of this year’s results
Value is a measure of long-term worth
Quiz 3 – Why doesn’t value = profit * P/E ratio?
•
3
Income less Outgo
New Business Strain
“Typical” Profit Signature
6
4
Shareholder Profit
2
0
-2
-4
-6
-8
-10
-12
-14
1
2
3
4
5
6
Year
4
7
8
9
10
“Typical” Projection
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
Yr 6
Yr 7
Yr 8
Yr 9
Yr 10
Premium
Invest E
500
47
450
53
405
105
364
156
328
166
295
254
265
302
239
349
215
397
194
442
Initial Exp
Ren Exp
Death
Surrender
Inc Res
258
75
250
47
47
68
235
92
98
61
221
135
78
55
208
176
62
49
195
216
9
44
183
255
37
40
172
293
28
36
162
330
20
32
152
367
16
29
143
403
11
-130
10
15
20
25
30
35
40
45
50
Profit
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1.
The loss in the first year is often called New business Strain.
2.
Over the life of the policy we expect PV profit to be positive.
What’s wrong with Statutory Profit?
Profit drivers for Statutory Reporting incorrect!
• Shows a loss when writing lots of profitable
new business when in value is actually added
• Shows a gain when policies cancels when
value is actually lost
A growing company writing profitable business
can have a negative statutory profit for many
years, but is generating a lot of value for it’s
shareholders.
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I. Why Calculate Embedded Value
Reasons to Calculate Value
•
•
A measure of performance
To calculate Return On Equity (ROE)
•
•
•
•
7
Increase in value / starting value
Carrying value in accounts of owner
Sale or Purchase
Management bonus
II. What is Embedded Value?
Embedded Value comes from three segments:
1. Net Worth (Assets – Liabilities)
2. PV of profit from in-force business
3. PV of profit from future sales
Sometimes:
• 1 + 2 is referred to as Embedded Value
• 1 + 2 + 3 is referred to as Appraisal Value
8
III. Net Worth
Net Worth = Assets – Liabilities
Assets
• Market Value of Assets
• Costs of sale of investments / assets (tax, fees)
• Value of some assets depends on purpose of
calculation.
•
•
Difficult to value some assets
•
•
•
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In a sale situation computer software may have no value.
Intangible assets (e.g. Goodwill) often set to zero
Property, direct holdings, … have no ready market value
Do deferred tax assets have value?
III. Net Worth
Net Worth = Assets – Liabilities
Liabilities
• Local Indonesian policy reserves
• Should include RBC requirements
•
•
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Cannot be distributed
Market Value of other liabilities
IV. Value of In force (VIF)
Definition
VIF = Present Value of future Distributable Profits
from in force policies
Distributable Profits
= Statutory Profits less increase in required RBC
Statutory Profits
= Premium + II – claims – expenses – change Resv tax
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IV. Value of In force (VIF)
Assumptions
VIF = Present Value of future Distributable Profits from inforce policies
Assumptions
• Best estimate assumptions needed
•
•
•
•
•
•
•
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Mortality/Morbidity
Interest earnings
Inflation
Lapses
Expenses
Tax
etc.
IV. Value of In force (VIF)
Risk Discount rate
Profits are discounted at the Risk Discount Rate (RDR)
RDR represents
• The company’s minimum desired rate of return on
capital
• Sometimes referred to as the “hurdle rate”
RDR should reflect:
• the Expected Shareholder’s return
• the risk that future profits will not match expectations
(risk profile of the business)
• the current local market conditions
13
IV. Value of In force (VIF)
Risk Discount Rate
Profits are discounted at the Risk Discount Rate (RDR)
• The RDR is key to the final Embedded Value figure
• Often a range of figures is used to show sensitivity
• CAPM says
•
•
Currently perhaps
•
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RDR =Risk free + Beta * (Market Rate – Risk Free)
RDR = 14.0 + 1.2 * (20.0 – 14.0) = 21.2%
V. Value of New business (VNB)
VNB = Present Value of future Distributable Profits
from future sales.
Assumptions
• Same issues as VIF
• How many years New business?
•
•
Additional Assumptions
•
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Judgment but often around 5 years.
Future sales growth, agency size, productivity,
product mix, …
VI. Other Issues
•
Expense Over-run
•
•
Minimum or target RBC ratio
•
•
How should we treat later year losses (25 years from now!)
Investment Return
•
•
•
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120% or 150% of estimated RBC
Later year losses
•
•
Expense budget versus Expense allowables
Should be consistent with asset valuation.
Should a change in asset mix affect value?
Can we forecast changes to current rates?
VI. Other Issues
•
It is extremely important that future bonus rates on
with-profit policies should be consistent with:
•
•
•
•
Future Sales (Value of New Business)
•
•
•
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Future assumptions.
Likely future management action
Policy holders reasonable expectations
Can we assume a re-price of loss making products
Are future margins going to be the same as today?
Should we use a higher RDR because of greater uncertainty?
VI. Other Issues
•
Product Guarantees
•
•
Valuation Software
•
•
•
•
Many available (e.g. Prophet, VIP, AXIS, MOSES, etc)
Possible but cumbersome to do in spreadsheets
Model points Vs seriatim data.
Changing Assumptions
•
•
•
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Investment /mortality – no value in deterministic approach
How often depends on purpose
Assumptions are long term to try to not have big swings
Future improvements in mortality
VII. Question & Answer
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