Presentation on theme: "An Introduction to Embedded Value"— Presentation transcript:
1An Introduction to Embedded Value Peter Erlandsen, CFO, ManulifeRio Winardi, Chief Actuary, Astra CMGSimon, Chief Accountant, Panin lifeDate: 8 December, 2005
2AGENDA Why Calculate Embedded Value? What is Embedded Value? Net Worth Value of In-ForceValue of new businessOther IssuesQuestion & Answer
3I. Why Calculate Embedded Value An Introduction Embedded Value Estimates Value.Quiz 1 - What Does Profit Measure?Income less OutgoQuiz 2 – Why is Profit not a measure of Value?Profit is a measure of this year’s resultsValue is a measure of long-term worthQuiz 3 – Why doesn’t value = profit * P/E ratio?New Business Strain
5“Typical” ProjectionThe loss in the first year is often called New business Strain.Over the life of the policy we expect PV profit to be positive.
6What’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 addedShows a gain when policies cancels when value is actually lostA 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.
7I. Why Calculate Embedded Value Reasons to Calculate Value A measure of performanceTo calculate Return On Equity (ROE)Increase in value / starting valueCarrying value in accounts of ownerSale or PurchaseManagement bonus
8II. What is Embedded Value? Embedded Value comes from three segments:Net Worth (Assets – Liabilities)PV of profit from in-force businessPV of profit from future salesSometimes:1 + 2 is referred to as Embedded Valueis referred to as Appraisal Value
9III. Net Worth Net Worth = Assets – Liabilities Assets Market Value of AssetsCosts of sale of investments / assets (tax, fees)Value of some assets depends on purpose of calculation.In a sale situation computer software may have no value.Difficult to value some assetsIntangible assets (e.g. Goodwill) often set to zeroProperty, direct holdings, … have no ready market valueDo deferred tax assets have value?
10III. Net Worth Net Worth = Assets – Liabilities Liabilities Local Indonesian policy reservesShould include RBC requirementsCannot be distributedMarket Value of other liabilities
11IV. Value of In force (VIF) Definition VIF = Present Value of future Distributable Profits from in force policiesDistributable Profits= Statutory Profits less increase in required RBCStatutory Profits= Premium + II – claims – expenses – change Resv - tax
12IV. Value of In force (VIF) Assumptions VIF = Present Value of future Distributable Profits from in-force policiesAssumptionsBest estimate assumptions neededMortality/MorbidityInterest earningsInflationLapsesExpensesTaxetc.
13IV. Value of In force (VIF) Risk Discount rate Profits are discounted at the Risk Discount Rate (RDR)RDR representsThe company’s minimum desired rate of return on capitalSometimes referred to as the “hurdle rate”RDR should reflect:the Expected Shareholder’s returnthe risk that future profits will not match expectations (risk profile of the business)the current local market conditions
14IV. 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 figureOften a range of figures is used to show sensitivityCAPM saysRDR =Risk free + Beta * (Market Rate – Risk Free)Currently perhapsRDR = * (20.0 – 14.0) = 21.2%
15V. Value of New business (VNB) VNB = Present Value of future Distributable Profits from future sales.AssumptionsSame issues as VIFHow many years New business?Judgment but often around 5 years.Additional AssumptionsFuture sales growth, agency size, productivity, product mix, …
16VI. Other Issues Expense Over-run Minimum or target RBC ratio Expense budget versus Expense allowablesMinimum or target RBC ratio120% or 150% of estimated RBCLater year lossesHow should we treat later year losses (25 years from now!)Investment ReturnShould be consistent with asset valuation.Should a change in asset mix affect value?Can we forecast changes to current rates?
17VI. Other IssuesIt is extremely important that future bonus rates on with-profit policies should be consistent with:Future assumptions.Likely future management actionPolicy holders reasonable expectationsFuture Sales (Value of New Business)Can we assume a re-price of loss making productsAre future margins going to be the same as today?Should we use a higher RDR because of greater uncertainty?
18VI. Other Issues Product Guarantees Valuation Software Investment /mortality – no value in deterministic approachValuation SoftwareMany available (e.g. Prophet, VIP, AXIS, MOSES, etc)Possible but cumbersome to do in spreadsheetsModel points Vs seriatim data.Changing AssumptionsHow often depends on purposeAssumptions are long term to try to not have big swingsFuture improvements in mortality