Transcript Headline copy goes here in MetaPlus 54pt
An Introduction to Embedded Value
Peter Erlandsen, CFO, Manulife Rio Winardi, Chief Actuary, Astra CMG Simon, Chief Accountant, Panin life Date: 8 December, 2005
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AGENDA
I.
II.
III.
IV.
Why Calculate Embedded Value?
What is Embedded Value?
Net Worth Value of In-Force V.
VI.
Value of new business Other Issues VII. Question & Answer
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•
I. Why Calculate Embedded Value A
n Introduction
Embedded Value Estimates Value.
• • Quiz 1 - What Does Profit Measure?
Income less Outgo • • • 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?
New Business Strain
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“Typical” Profit Signature
2 0 6 4 -10 -12 -14 -2 -4 -6 -8
1 2 3 4 5
Year
6 7 8 9 10
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“Typical” Projection
Premium Invest E Initial Exp Ren Exp Death Surrender Inc Res Profit
Yr 1
500 47 258 75 250 47 47 -130
Yr 2
450 53 68 235 92 98 10
Yr 3
405 105 61 221 135 78 15
Yr 4
364 156 55 208 176 62 20
Yr 5
328 166 49 195 216 9 25
Yr 6
295 254 44 183 255 37 30
Yr 7
265 302 40 172 293 28 35
Yr 8
239 349 36 162 330 20 40
Yr 9 Yr 10
215 194 397 442 32 152 367 16 29 143 403 11 45 50 1.
2.
The loss in the first year is often called New business Strain.
Over the life of the policy we expect PV profit to be positive.
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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) Increase in value / starting value Carrying value in accounts of owner Sale or Purchase Management bonus
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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
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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.
In a sale situation computer software may have no value.
• • • Difficult to value some assets Intangible assets (e.g. Goodwill) often set to zero Property, direct holdings, … have no ready market value Do deferred tax assets have value?
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III. Net Worth
Net Worth = Assets – Liabilities • • •
Liabilities
Local Indonesian policy reserves • Should include RBC requirements Cannot be distributed Market Value of other liabilities
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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 in force policies •
Assumptions
• • • • • • • Best estimate assumptions needed Mortality/Morbidity Interest earnings Inflation Lapses Expenses Tax etc.
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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
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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 RDR =Risk free + Beta * (Market Rate – Risk Free) • Currently perhaps RDR = 14.0 + 1.2 * (20.0 – 14.0) = 21.2%
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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?
Judgment but often around 5 years.
• Additional Assumptions Future sales growth, agency size, productivity, product mix, …
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VI. Other Issues
• • Expense Over-run Expense budget versus Expense allowables • • Minimum or target RBC ratio 120% or 150% of estimated RBC • • Later year losses How should we treat later year losses (25 years from now!) • • • • Investment Return Should be consistent with asset valuation.
Should a change in asset mix affect value?
Can we forecast changes to current rates?
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VI. Other Issues
• It is
extremely important
that future bonus rates on • • • with-profit policies should be consistent with: Future assumptions.
Likely future management action Policy holders reasonable expectations • • • • Future Sales (Value of New Business) 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?
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VI. Other Issues
• • Product Guarantees Investment /mortality – no value in deterministic approach • • • • • 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 How often depends on purpose Assumptions are long term to try to not have big swings Future improvements in mortality
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