Introduction to Market Consistent
Embedded Values
Rokas Gylys
Lithuanian Actuarial Association
Contents
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What is embedded value?
Key components of MCEV
Comparison EEV and MCEV
Interaction of Solvency II and IFRS
Discussion
What is EV?
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EV = Value of shareholders’ net assets + present value of net transfers
to shareholders from in force business
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EV profit = change in EV + net transfers to shareholders (dividends)
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EV is expected to show a more realistic financial position and results of
operations of an insurance company than current statutory regimes
Companies started to report in 1989, but lack of consistency initially
In 2004 European Embedded Value (EEV) principles were published by
European Insurance CFO Forum
4th June 2008 - CFO Forum published Market Consistent EV (MCEV)
principles
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Why Embedded Value Reporting?
£
NP Term Assurance - Earnings
80
60
40
20
0
-20
-40
-60
-80
-100
-120
0
1
2
3
4
Statutory Basis
5
Embedded Value
Policy Year
Local statutory measures of profit make a growing company look like it is
destroying value
Calculating an EV
In force
Policy Data
Assumptions
Calculator
1. Models of products
2. Project reserves
3. Project net
shareholder transfers
4. Discount
Outputs
Best estimates
for mortality,
lapses,
expenses,
investment
return etc.
MCEV – Components
The MCEV consists of the following components:
Free Surplus
Required Capital
• Free surplus allocated to the covered business
• Required capital; and
PVIF
• Value of in-force covered business (VIF)
The VIF consists of the following components:
TVFOG
• Present value of future profits (PVFP); less
• Time value of financial options and guarantees
Frictional Cost
• Frictional costs of required capital
• Cost of residual non-hedgeable risks
CRNHR
Total MCEV
MCEV – Components
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Free surplus is the market value of any assets allocated to, but not required
to support, the in-force covered business at the valuation date
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Required capital = MAX (Solvency capital, economic capital)
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Present value of future profits are post-taxation shareholder cash-flows from
the in-force covered business and the assets backing the associated
liabilities
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Time value of options and guarantees:
– Need to allow for financial asymmetries
– Market consistent methodology: usually stochastic approach is required for
valuation
– Allowance for dynamic policyholder actions and management discretion
MCEV – Components (2)
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Frictional costs of required capital
– Double taxation, investment expenses, any policyholder participation on returns
for assets required to back required capital
– Required capital at the greater of regulatory requirement or company target level
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Cost of residual non-hedgeable risks
– Insurance, operational, and other non-hedgeable risks disclosed through change
on economic capital required for those risks
Key features of MCEV
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A shareholder’s perspective on value: the present value of future cash-flows
available to the shareholder, adjusted for the risks of those cash-flows
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Not taking any credit for any future investment return in excess of risk-free
rates
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Reflecting the current market price of hedging financial risks
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With a transparent (?) allowance for non-hedgeable risks
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Reflecting the actual and expected experience of the specific business
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MCEV will be volatile if investment markets are volatile
MCEV – Comparison to EEV
Time Value
Options and
Guarantees
Value of
Future
Profits
(PVFP)
Cost of
Required
Capital
Time Value
Options and
Guarantees
Value of
Future
Profits
(PVFP)
Cost of
Residual NonHedgeable
Risks
Frictional
Costs of
Required
Capital
Net Worth
Net Worth
European EV
Market
Consistent EV
Interaction with Solvency II and IFRS
2007
Solvency II
Phase II
MCEV
2008
2009
Framework
Directive
Published
Discussion
Paper
2010
Level I & II
Directives
Exposure
draft?
Guidance
issued
Final
standard?
Effective from 2009
year end
2011
2012
Full
Implementation
Implementation?
Discussion
• Any questions or comments?
THANK YOU!