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Welcome to this special edition of the Insurance Market UpdateMarket Consistent Embedded Value (MCEV) reporting has not enjoyed a smooth ridesince its birth in 2008. It was unfortunate timing that MCEV came into force duringone of the most severe financial crises in more than 60 years. The volatile MCEVnumbers reported by insurers over the last few years, coupled with the very slowprogress towards applying a consistent methodology and the seemingly complexnature of this reporting metric, resulted in analysts and investors questioning themerits of MCEV. The 2010 MCEV reporting season showed some signs ofconvergence in methodology forced by regulatory regimes (mainly Solvency II). It wasalso characterised by the steady decline in the prominence of MCEV in insurers’financial reports with more focus being given to IFRS earnings, cash flow and capitalgeneration. Even with the uncertain future of MCEV, it is still one of the key metricswithin the insurance sector and the knowledge developed in producing thesenumbers forms the cornerstone of the quantitative skills required for Solvency II andIFRS 4 Phase II.
This year’s special edition of the Insurance Market Update analyses the resultspublished by 19 major European insurers, although our focus is principally on thosecompanies with UK operations.
In this article we draw out some of the key themes that have emerged over the lastcouple of years, by comparing embedded values across the industry. We also analysethe disclosures and their merits, and the relationship between embedded value andshare price. Finally, we discuss what the future of embedded value might look like.
We are always interested to get your feedback and hear your views on the topics wecover. If you would like to contribute to the debate, or ask questions of our experts,please speak to your usual Deloitte contact, or one of the team listed at the end ofthis article.
Roger SimlerPartner – Actuarial & Insurance Solutions
Market Consistent Embedded ValueAt a turning point
July 2011
MCEV: At a turning point 2
Methodology and assumptions2010 could be the point at which convergence inapproach to determining MCEV started in earnest.Most insurers in our sample are now adjusting theiryield curve for illiquidity premium and are calculatingtheir Cost of Residual Non-Hedgeable Risk (CRNHR)using the cost of capital methodology in a very similarway to the Solvency II framework.
In 2010 we have seen a mix of market consistent andnon-market consistent embedded values. As the MCEVPrinciples are not currently compulsory, and with theCFO Forum’s move away from making MCEV the solereporting methodology, we do not expect to see anincrease in convergence in this area.
Economic varianceSome insurers in our sample showed significant(negative) economic variance. As ‘economic variance’includes both market movements and economicassumption changes it is difficult to analyse thegenuine impact of market movements as opposed tomanagement decisions.
DisclosureThere has been a clear sign in disclosures of theincreased prominence of cash flow, capital generationand IFRS earnings. Market reaction to the complexity of MCEV is likely to have played a large part in thistrend. In our view, cash flow reporting is a usefuladdition to insurers’ disclosure but it should not berelied upon exclusively as an indicator of performance.The cash flows rely on the same embedded valueassumptions and do not help in understanding theeconomic risk affecting shareholder value.
Embedded value versus share priceSince the start of the financial crisis and the resultingsell-off of insurance stocks, the life sector performancehas dropped and has been consistently lower than themarket. If embedded values are believed to be a goodreflection of an insurer’s value then market capitalisationshould be higher than embedded value; this has notbeen the case for the majority of our sampledcompanies. There are a number of reasons why marketcapitalisation and embedded value will always diverge,however in our view the combination of the complexityand volatility of MCEV with the frequent changes inmethodologies, does not help investors’ or analysts’acceptance of this metric.
Embedded value post Solvency II and IFRS 4Phase IICould we be seeing the end of the embedded valueera? With Solvency II and IFRS 4 Phase II coming intoforce in the near future, will embedded value survive? Both these regimes use calculation techniques similar to those applied in embedded value and will, withpotentially minor changes, convey similar information.This may reduce the impetus for embedded valuereporting. It is our view that insurers should considerhow Solvency II and IFRS 4 Phase II can be used toconvey management’s view of value. This may be usedas an opportunity to simplify their reporting.
Deloitte view
MCEV: At a turning point 3
Methodology
Aviva considers that its experience in managing creditand insurance risk means it is confident of realising thespread margins in the real-world. Figure 1 belowrepresents the main difference in the yield assumptionsbetween the ‘Equivalent Embedded Value’ and theMCEV approaches, and looks at the impact that this hason Aviva’s shareholders’ equity.
Aviva’s aim of this additional reporting is to make thecomparison to its UK peers publishing under the EEVmethodology easier for analysts and investors, as wellas showing investors that there is more value in thebusiness than currently reflected in the share price. We acknowledge Aviva’s concerns regarding its MCEVfigures and recongnise the importance of reflecting anaccurate view of value. However, adding yet anothervariant to embedded value may only serve to increaseanalysts’ perception of the complexity of life insurance,while moving further away from the CFO Forum’s aimof harmonising embedded value reporting.
Figure 1. Aviva ‘Equivalent Embedded Value’ vs. MCEV
MCEV assumptions
Expected default
Liquidity premium
Spread earnings
Yield
Portfolio
Swap rate
Duration
‘EquivalentEmbedded
Value’ assumptions
Source: Aviva disclosure & Deloitte analysis
‘Equivalent Embedded Value’(YE 2010) = £18.3bn or 657p per share
‘MCEV’ (YE 2010) = £16.1bn or 579p per share
As compliance with the MCEV Principles was notmandatory as at year-end 2010, insurers continued topublish embedded value using a variety of approaches.Based on our sample of 19 companies, 11 reportedunder the MCEV Principles published by the CFO Forumin October 2009, four companies reported under theEEV Principles using a market consistent approach andthe remaining four reported under the EEV Principleswithout being market consistent.
In April 2011, the CFO Forum withdrew its intentionthat MCEV should be the only recognised format ofembedded value reporting from 31 December 2011.This decision was driven by the ongoing developmentof insurance reporting under Solvency II and IFRS. TheCFO Forum, however, remains committed tosupplementary reporting, including embedded value.Given this situation, we do not expect to see furtherconvergence in approaches any time soon.
In addition to the above mentioned embedded valuemethodologies, Aviva introduced a new variant ofembedded value called ‘Equivalent Embedded Value’.Aviva’s aim is to “provide enhanced embedded valueinformation to allow a direct comparison to EEV”.1
Contrary to some of its UK peers publishing a non-market consistent EEV, Aviva uses a market consistentapproach which does not give credit to any return dueto spreads earned on corporate bonds.
1 Aviva analyst presentation as at January 2011.
MCEV: At a turning point 4
Assumptions
For year-end 2010 there is evidence of assumptionsconverging towards the expected Solvency IIspecifications. For example, in Allianz’s MCEVpresentation the three main assumption changes wereclearly made to achieve greater consistency with itspeers and the Solvency II Directive. These changes aresummarised in Table 1.
A table summarising each sampled company’sassumptions is provided in the appendix. Below wecomment on the key features and emerging trends inthese assumptions.
Liquidity premiumMost insurers (13 out of the 19 companies in oursample) are now adjusting their yield curve to allow foran illiquidity premium. This includes some of the majorEuropean players who were initially sceptical about thecase for illiquidity premium, such as Allianz and ZurichFinancial Services (the latter who plans to include anilliquidity premium by year-end 2011). Furthermore, ofthe 12 out of 13 companies that disclosed themethodology used to calculate the illiquidity premium,half used the CFO/CRO Forum and QIS 5 recommendedformula [Max(0, 50% × (Spread – 40bp))]. Allcompanies using this approach bucketed their liabilitiesin-line with the recommendations so that the differentlevels of illiquidity premium (i.e. 100%, 75% and 50%)are applied in-line with the nature of the liabilities.
Cost of residual non-hedgeable risk (CRNHR)The CRNHR used to be an area where insurers divergedsignificantly; this year we have seen the first signs ofconvergence beginning. Of our sample, 11 calculatedthe CRNHR as a cost of capital charge applied to thecapital required to cover the non-hedgeable risks. The capital charge applied by 5 of those 11 companieswas 4.0% (including Zurich Financial Services which willapply the 4.0% at year-end 2011). This is consistentwith the CRO Forum recommendation2 which indicatedthat a suitable charge is in the range 2.5% – 4.5%. The capital charge for the CRNHR is lower than thecharge applied in calculating the risk margin under theSolvency II framework. Insurers may be using thepublication of MCEV as a means to lobby the regulatorto lower the Solvency II capital charge.
There remain differences in the treatment ofdiversification between covered and non-coveredbusinesses in the CRNHR. MCEV Principle 9.7 prohibitsthe use of this diversification. Some companies believethat this does not reflect the risk management processand have made some allowance for diversification. If the CFO Forum introduces future amendments to the MCEV Principles, this might be an area for review.
Volatility and reference ratesVolatility and reference rates are the two assumptionswith greater consistency. During the financial crisiswhen markets were dislocated, insurers applieddifferent adjustments to volatilities and reference rates.Now that markets are generally accepted to havereturned to more normal levels, all insurers reportingunder a market consistent approach are using the swaprates (where there is a deep and liquid market) andimplied volatilities at the calculation date.
Table 1. Allianz’s key assumptions changes
Allianz assumption change
Impact on (EUR)
New businessvalue
MCEV
Inclusion of illiquidity premium:In-line with the CFO/CRO Forum recommendation +113m +1.7bn
Yield curve extrapolation:In-line with EIOPA guidance
+45m +0.6bn
Cost of capital charge for non-hedgeable risk:In-line with major European peers (equivalent to 4% charge on risk capitalcalculated at 99.5% confidence level)
+47m +0.5bn
Source: Allianz analyst presentation as at 25 February 2011
2 Paper titled: Market Value of Liabilities for Insurance Firms, Implementing elements for Solvency II, June 2008.
MCEV: At a turning point 5
Figure 2. Global Life embedded value by region for years 2008 – 2010 (£m)
UK
Europe
Rest of World
-5,000
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
BaloiseGroupamaKBCStorebrandSwiss LifeAgeasStandard LifeResolutionOld MutualLegal & GeneralLBGZFSMunich ReAvivaPrudentialGeneraliAllianzAxa
Source: Companies’ disclosure & Deloitte analysis
Notes:– Baloise did not publish an MCEV in 2008.– Groupama: the embedded value for Europe is only that of French business. The rest of the world figure contains all other businesses. – Resolution: Continental Europe represents the embedded value of Lombard.– Standard Life: the rest of the world figure contains the embedded value of the German and Irish branches as well as the rest of the international business.– Swiss Life: the embedded value includes the private placement life insurance through Singapore.
YearLegend
Company
2010
2009
2008
AX
A
Alli
anz
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Prud
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We have expanded the number of insurers in oursample from 16 in last year’s special edition to 19 in this year’s. The comparisons below with last year’snumbers are done on a like-for-like basis.
2010 was a year where most insurers in our samplesaw an increase in embedded value. 15 out of the19 companies produced a positive return on embeddedvalue (in local currency) bringing the aggregateembedded value for long term covered business to£201bn, an increase of 7.6% (including the effect ofexchange rate changes) compared to 2009.
Of the £201bn, £43bn is written in the UK, £99bn inContinental Europe and £59bn in the rest of the world.Figure 2 below shows the total embedded value foreach company over the last three years (in descendingorder) split by region.
Results
MCEV: At a turning point 6
AXA remains the largest insurer (measured by theembedded value of the covered business) in our samplewith a considerable margin over Allianz and Generali.In 2010, AXA sold most of its UK business to Resolution(with the combined portfolio of Friends Provident, AXAand BUPA now renamed Friend’s Life) which significantlyreduced its UK embedded value. AXA has subsequentlytaken over full control of its Asia-Pacific business afteralmost 18 months of negotiation. This consolidation,which happened in April 2011, does not show in theembedded value numbers in this article.
The UK life insurers have reported a strong set of resultsfor 2010 with upbeat messages from their CEOs and anincrease in dividend payments. Both Aviva andPrudential reported significant increase in new businesscontribution in the UK market (see page 9).
The top three performers in terms of return onembedded value (ignoring the effect of Resolution‘sacquisition of AXA’s UK business) were Old Mutual,Swiss Life (based on return in CHF) and Prudential. Old Mutual attributed this to positive marketmovements, lower yield curves and tax deductions onincome and gains as a result of the current tax positionof the UK tax group. In addition, the strengthening ofthe Rand, Dollar and Krona relative to Sterling had asignificantly positive effect on the MCEV (which isreported in Sterling). Swiss Life’s increase in MCEV waslargely driven by assumption changes such as futuremortality, morbidity and longevity rates. The effect ofthe ongoing cost reduction programme and a revisedpolicyholder bonus approach, driven by the low interestrate environment, gave the MCEV a significant upswing.The effect of these changes represented 20% of theopening MCEV. It is not clear what level ofmanagement discretion has been applied in arriving atthese changes. Prudential’s embedded value increasedby 19%, largely driven by the 31% increase in its Asianbusiness embedded value.
The worst performer was Groupama with a drop inembedded value of 21%, attributed largely to economicconditions, the new tax regime in France and anincrease in future bonus rates assumption.
One of the striking features of embedded value results in2010 was that nearly two thirds of insurers in our samplereported negative economic variance. Most companieswith negative economic variance attributed this to lowerinterest rates, widening sovereign bond spreads, higherinterest rate volatilities and higher credit spreads. As shown in Table 2 below, the economic environmentmainly had an adverse effect on Continental Europeaninsurers, whereas the UK based insurers seem to haveweathered the market situation much better. Under thecurrent MCEV guidelines, companies are not obliged tosplit the impact on embedded value of the marketmovement and the economic assumption changes,hence the economic variance is the total of those twoelements. This approach lacks the transparency neededto understand the genuine impact of market movementas opposed to management decisions. For example, overoptimism on illiquidity premium does not show up as aseparately disclosed item, but is buried within theeconomic variance.
Table 2. Economic variance as % of opening embedded value
Source: Companies’ disclosure & Deloitte analysis
Economic variance as % of opening embedded value
Old Mutual 13% ZFS -5%
Std Life 10% Munich Re -7%
Storebrand 3% Allianz -10%
Resolution 3% KBC -11%
LBG 3% Generali -14%
Legal & General 2% Groupama -18%
Aviva 1% Fortis-Ageas -19%
Prudential -1% Swiss Life -24%
Axa -4% Baloise -26%
CNP -5%
MCEV: At a turning point 7
Sensitivities
We have analysed the available economic sensitivities to better gauge the potential impact of market movement on the insurers’ embedded value.Table 3 below summarises those sensitivities.
Illiquidity premium Risk free rateEquity/property
valuesVolatilities
Company10bp increase
to referencerates
Removepremium
+100bps -100bps -10 % Equity +25%Interest rate
+25%
Axa 2% -4% 2% -6% -5% -2% -3%
Allianz – -6% 8% -15% -4% -3% -2%
Aviva 2% – -1% -1% -5% -2% -2%
Baloise – -9% 24% -32% -13% -3% -3%
CNP 0% – 0% -1% -4% -4% -2%
Ageas 2% -8% 5% -15% -7% -5% -1%
Generali 1% -6% 4% -8% -6% -2% -1%
Groupama – – -7% 6% -16% -7% -2%
KBC – – 0% -1% -2% – –
Legal & General – – -2% 2% -2% – –
LBG 1% – – 2% -3% – –
Munich Re 3% – 6% -11% -1% -2% -1%
Old Mutual 1% – -3% 3% -5% -2% -1%
Prudential 1% – -3% 3% -3% – –
Resolution – -7% -2% 2% -4% 0% 0%
Standard Life – – 0% -2% -5% – –
Storebrand – – 6% -19% -11% -3% -6%
Swiss Life – – 10% -17% -16% -6% -5%
ZFS 1% – -1% -4% -3% -1% -1%
Source: Companies’ disclosure & Deloitte analysis
Notes: – ZFS did not include an illiquidity premium in the year-end 2010 embedded value but will include one at year-end 2011. The ZFS illiquidity premium sensitivity listed
above was shown to illustrate the potential impact.– Allianz did not disclose the impact of the illiquidity premium in the embedded value report but showed its impact in the analyst presentation.
Table 3. Economic sensitivities
MCEV: At a turning point 8
Embedded value reporting is currently the main reporting metric showing a wide range of sensitivities, allowinginvestors and analysts to understand the economic risk affecting shareholder value. Analysing sensitivities gives aview of the companies’ potential asset and liability mismatch, and the opportunity for reducing volatility throughhedging. The first MCEV reporting coincided with the beginning of the financial crisis which dislocated the marketand resulted in unpredictable and volatile embedded value results. This made it difficult for investors, analysts andeven insurers themselves, to accept that the embedded value numbers fully represented the true outlook for theunderlying business. As the insurance industry moves closer to the implementation of market consistent techniquesthrough Solvency II and IFRS 4 Phase II, stakeholders will develop a better understanding of the embedded valueresults (assuming embedded value reporting survives – see page 12).
Given the decrease in the yield curves between 2009 and 2010 in most countries (except Sweden which mainlyaffects the results of Storebrand) the economic variance shown in Table 2 is largely consistent with the sensitivitiesof the embedded value to interest rate movements. These sensitivities are shown in Figure 3 below. Aviva showsone of the smallest sensitivities to interest rate movement (as well as the smallest economic variance); this is likely to be due to its hedging strategy. Baloise is showing the biggest sensitivity to a decrease in interest rate movement (-33%) probably explained by an asset and liability mismatch. Compared to Swiss Life, one of its peers in the Swissmarket, the contrast is marked. Swiss Life’s interest rate sensitivity dropped from -37% in 2009 to -17% in 2010.This implies that Swiss Life took action to protect its financial position from interest drops whereas Baloise, which isstill showing a similar level of sensitivity as in 2009, seems to be betting on an increase in interest rates.
Figure 3. Embedded value sensitivity to interest rate movement
Risk free rate +100bp
Risk free rate -100bp
Source: Companies’ disclosure and Deloitte Analysis
Note: Lloyds Banking Group and Old Mutual do not report sensitivity to interest rate movement.
EEVCompanies reporting under MCEV or market consistent EEV
Bal
oise
Stor
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-40%
-30%
-20%
-10%
0%
10%
20%
30%
MCEV: At a turning point 9
New business
The total volume of new business of our 19-company sample (as measured by present value of new business premium – PVNBP) increased by 4%to £329bn. Over the same period the value of new business (net of tax) increased to £7.8bn, an increase of 15%, reflecting an improvement inthe underlying margins.
Figure 4. New business volumes (measured by PVNBP) by region for years 2008 – 2010 (£m)
Source: Companies’ disclosure and Deloitte Analysis
UK
Europe
Rest of World
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
YearLegend
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2010
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AX
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LBG
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l & G
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n
Gro
upam
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Age
as
Balo
ise
Stor
ebra
nd
KBC
Figure 5. Value of New Business (net of tax) by region for years 2008 – 2010 (£m)
Source: Companies’ disclosure and Deloitte Analysis
UK
Europe
Rest of World
-500
0
500
1,000
1,500
2,000
YearLegend
Company
2010
2009
2008
Prud
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MCEV: At a turning point 10
The UK value of new business showed a significantincrease in 2010, helping drive embedded value andoperating profits higher. Lloyds Banking Group has thelargest value of new business in the UK, but Legal &General has narrowed the gap. Based on our sampleinsurers, the UK value of new business increased by17%, although volume (as measure by PVNBP) onlyincreased by 6% indicating a shift towards highermargin business such as protection and annuities inaddition to improving capital efficiency and bettermarket conditions. Bulk annuity business contribution to new business volumes showed significant increase,particularly at Aviva and Prudential (four fold increase to £871m and 13% increase to £820m respectively). The area where Aviva and Prudential differ significantlyis in their US new business. Despite improvements in2010, Aviva’s US business continues to underperform,with a reported negative value of £(194)m (with an IRRof 14% and a payback period of four years)3 andcontinued speculation around future sale of thisbusiness. Prudential’s US business is seen as animportant contributor to growth with value of newbusiness of £495m (with an IRR in excess of 20% and apayback period of one year). It should be noted that asAviva uses an MCEV approach compared to Prudential’sEEV approach a direct comparison of these numberscannot be made.
A key development that will affect new businessvolumes in the UK is the implementation of the RetailDistribution Review (RDR) which will take effect on 1 January 2013. As intermediaries will no longer be ableto accept commissions for recommending insuranceproducts to UK retail customers, it is expected that RDRwill reduce churning of business and hence affect newbusiness volumes. It remains to be seen what the fullimpact of the RDR will be, but different companies areclearly pursuing different strategies.
3 Value on new business calculated on an MCEV basis. IRR and payback period calculated on a “real world” basis.
MCEV: At a turning point 11
Disclosure
Disclosure of insurers’ results is continuously evolvingand each year provides new additions. The annualreports of Aviva and Prudential have become soexhaustive that they are now nearly as big as companiessuch as Barclays. There is a fine line between increasingvolumes of useful information and informationoverload, and companies should guard against thelatter.
Insurers, in particular UK based ones, are shifting thefocus of their disclosure from embedded value to IFRSearnings and cash flows. This is partly driven by themarket reaction to the complexity of MCEVs. By disclosing cash flow and capital generation, theinsurance industry hopes to show investors that the lifeindustry can generate cash in the short term. This is alsoapparent in insurers’ push to shorten the paybackperiod for new business.
A clear example of this trend in disclosure is illustratedby Prudential’s cash flow reporting which has beendeveloped from the now typical five year grouping ofcash flows, into an annual cash flow disclosure (seeFigure 6 below). We expect other companies to followPrudential’s approach in 2011 and Legal & General, at their analyst meeting, committed to providingenhanced disclosures.
Cash and capital generation has become a metric thatinvestors are using to judge life insurers’ performanceand drive their share price. Investors and analysts weredisappointed when Legal & General lowered its cashflow target for 2011 (to £700m from £728 generatedin 2010). While the additional disclosure of cash andcapital generation met with approval from investors andhelped to improve the transparency of the results, itshould not be relied on exclusively to judge acompany’s performance. One should not forget thatthose cash flows are generated using the sameassumptions as the embedded value and are not certain.Reality might prove the assumptions used to be wrong.In addition, cash flows do not tell us about the riskunderlying the insurers’ liability. In our view cash flowreporting is a useful addition to the insurers’ disclosure,but it should not be relied on exclusively as an indicatorof performance.
Figure 6. Prudential and Aviva cash flow disclosure
Source: Aviva and Prudential disclosure
Note: Aviva’s free surplus reporting is based on the ‘Equivalent Embedded Value’ cash flows.
0
2
4
6
8
10
20+16-2011-156-100-50.0
0.5
1.0
1.5
2.0
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Aviva undiscounted free surplus (£bn)Prudential undiscounted free surplus (£bn)
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
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8.0 6.4 5.2 4.5
MCEV: At a turning point 12
The future of embedded value
Embedded value versus share price (includingnon-covered business)The life insurance industry historically performed broadlyin line with the market. Since the start of the financialcrisis and the resulting sell-off, the sector has notreturned to its previous highs and has consistentlyunderperformed the market (see Figure 7).
One would expect that embedded value (including non-covered business) should give a reasonable indication ofwhat the market capitalisation of an insurance companyshould be. There are many reasons why embeddedvalues and market capitalisation will diverge, includingthe absence of new business in an embedded value,timing issues and the complexity of some of thecalculations.
Assuming an insurer is writing profitable new businessits market capitalisation should, all other things beingequal, exceed the embedded value. Based on insurers inour sample, only Zurich Financial Services (which has asubstantial non-life business not reflected in theembedded value) and Baloise (which is well positionedto benefit from a potential increase in interest rate – seepage 8) were trading at a higher multiple to theembedded value as at year-end 2010 (see Figure 8).
Figure 7. Market vs. life assurance sector performance
FTSE 350 index
20092008200720062005 2010
FTSE 350 Life Assurance Index
0
20
40
60
80
100
120
140
0
5,000
10,000
15,000
20,000
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45,000
50,000
BaloiseStorebrandAgeasSwissLife
ResolutionStandardLife
Legal &General
Old MutualCNPAvivaPrudentialGeneraliZFSAXAAllianz
Figure 8. Group embedded value vs. market capitalisation (£m)
Group embedded value(including non-coveredbusiness)
Market capitalisation
Analyst Target Market Cap
Source: Companies’ disclosure and Deloitte analysis
Note: – Market cap as at 31 December 2010.– Lloyds Banking Group, KBC (bankassurer), Munich Re (reinsurer) and Groupama (mutual) were excluded from this analysis as their market cap is not directly comparable to embedded value.– Aviva, Generali, Legal & General, Old Mutual, Prudential, Resolution, Standard Life, Storebrand analyst target based on Thomson Reuters.– The analyst target for Allianz is based on Commerzbank report, AXA and CNP is based on Societe Generale report, Ageas is based on KBC report, Swiss Life and Baloise is based on Deutsche Bank report and ZFS is based on Collins Stewart report.
MarketCAP/Group EV: 80% 85% 110% 92% 93% 72% 66% 68% 73% 67% 52% 57% 93% 59% 177%
MCEV: At a turning point 13
Is this telling us that embedded value has becomedisconnected from the share price? Or has the insuranceindustry simply confused investors and analyst with amyriad of metrics? It should be noted that our sampleinsurers have their business primarily in the UK, Europeand US with the exception of Prudential with substantialAsian presence. Looking at insurers’ valuations in SouthEast Asia we observe that when AXA took full ownershipof AXA APH the deal valued AXA APH at more thantwice its 2010 embedded value. AIA is currently valuedat 1.5 × embedded value and Ping An (a Chinese insurer)is currently valued at 3 × embedded value. A possibleconclusion is that investors do not believe in the growthprospects of life insurance in Europe and are moreinterested in the potential of the emerging markets.This results in investors discounting more heavilyEuropean based insurers with no presence in thosemarkets. European based insurers are all striving toimprove their share prices, in part supported by theirextensive disclosures, though arguably this has not hadthe desired effect. Perhaps insurers should try to simplifytheir disclosure, report using a main metric which iskept consistent year-on-year to allow their key messagesto come through in their results. With Solvency II andIFRS 4 Phase II now on the horizon, the insurers’ taskwill be rendered even more challenging unless action istaken to cut through the range of competing measures.
A history of embedded value or… is embeddedvalue history?A recent article4 published by Deloitte consideredwhether embedded value will still have a futurealongside Solvency II and IFRS 4 Phase II. In the newworld, post Solvency II and IFRS 4 Phase II, investorslooking to back business models and managementteams over the long term may be reluctant to digestcomplex presentations of profits prepared using two orthree potentially contradictory methodologies. SolvencyII and IFRS 4 Phase II are based on market consistenttechniques similar to those of MCEV. The articlequestioned if it is now time to consign embedded valueto the history books, replacing its function with aversion of the balance sheets and analysis that willemerge from Solvency II. For this proposal to work theanalysis will need to reflect management’s view of thebusiness and not just the regulator’s.
The industry still feels there are a number of areaswhere the regulator is taking an overcautious view andthat the proposed regulations do not appropriatelyreflect the management view. Companies could use the‘Own Risk and Solvency Assessment’ (ORSA) as a tool toput forward their view of the business. The articlesuggests three key criteria to ensure this alternativeapproach would work. First, allow very limited scope forassumption changes to minimise inconsistencies.Secondly, management’s view should diverge fromSolvency II in only the most material areas where thereis a perception of excessive strength in the regulatoryview. Thirdly, open and direct dialogue with theinvestment community will be required to support a fullunderstanding of the underlying business dynamics.
The reality is that we are on a journey that will seesignificant changes in financial reporting over thecoming years. Companies should include in theirSolvency II programmes a view of how they would likeSolvency II and IFRS 4 Phase II to affect the way theycommunicate to the market, and start making thenecessary preparations now.
4 Insurance Market Update (April edition): http://www.deloitte.com/view/en_GB/uk/industries/financial-services/sector-focus/insurance/50baed4af469f210VgnVCM2000001b56f00aRCRD.htm.
In the new world, post Solvency II andIFRS 4 Phase II, investors looking toback business models and managementteams over the long term may bereluctant to digest complex presentationsof profits prepared using two or threepotentially contradictory methodologies.
MCEV: At a turning point 14
Conclusion
Embedded values have been around since the 1980s andhave seen continuous developments and changes,receiving mixed reactions from the investmentcommunity. Embedded value is again at a turning point,with the new world of Solvency II and IFRS 4 Phase II onthe horizon. Only time will tell which direction it will take.Looking back at 2010, the embedded value reportingseason has provided some conflicting messages. On theone hand there have been some tentative signs ofconvergence in methodology and assumptions, driven by regulatory changes, which should improve investors’and analysts’ acceptance of this metric and fulfil the long term aim of the CFO Forum.
On the other hand, the information presented hasshown that embedded value has slipped down the listof key reporting metrics with IFRS earnings, cash flowand capital generation taking more prominent roles. Life insurance in general and embedded value inparticular is perceived as complex. The opacity of someof its elements such as economic variance and CRNHRdoes not help dispel this image. This lack of transparencymay explain why most insurers in our sample weretrading at year-end 2010 at a discount to embeddedvalue. In whatever shape embedded value emerges,post Solvency II and IFRS 4 Phase II, in our view insurersshould consider how they can convey management’sview of value in a consistent, stable and transparentway. These changes present an opportunity to reduceand simplify a company’s reports rather than beingviewed as increasing the reporting burden and complexity.
MCEV: At a turning point 15
Appendix: Embedded Valueyear-end 2010 assumptionssummary
MCEV: At a turning point 16
Co
mp
any
Met
ho
do
log
yIm
plie
d D
isco
unt
Rat
e (I
DR
)R
efer
ence
Rat
esIll
iquid
ity
Pre
miu
ms
(Met
ho
do
log
y)Ill
iquid
ity
Pre
miu
ms
(Val
ue
in b
ps)
Vo
lati
litie
sC
RN
HR
Age
asEE
V
(Mar
ket
Con
sist
ent)
No
t d
iscl
ose
dSw
ap r
ate
at 3
1 D
ecem
ber
2010
for
the
rele
vant
cur
renc
ies
wit
h 10
bps
dedu
ctio
n ac
ross
the
ent
ire
curv
e.
Age
as u
ses
a w
eigh
ted
aver
age
liqui
dity
prem
ium
for
eac
h in
sura
nce
com
pany
bas
edon
the
ir li
abili
ty m
ix.
• EU
R:
23 –
34
• H
ong
Kon
g: 2
8 –
35•
US:
46
– 50
Impl
ied
vola
tilit
y 31
Dec
embe
r 20
10,
exce
pt f
or p
rope
rty
vola
tilit
ies
whe
rehi
stor
ic m
arke
t da
ta is
use
d.
Cha
rge
of 0
.5%
on
proj
ecte
d to
tal r
equi
red
equi
ty.
Alli
anz
MC
EVN
ot
dis
clo
sed
Swap
rat
es 3
1 D
ecem
ber
2010
CFO
/CR
O F
orum
and
QIS
5 il
liqui
dity
for
mul
a *
• EU
R:
59
• C
HF:
7•
USD
: 64
Impl
ied
vola
tilit
y 31
Dec
embe
r 20
10,
exce
pt f
or p
rope
rty
vola
tilit
ies
whe
rebe
st e
stim
ate
leve
ls a
re u
sed.
Equi
vale
nt 4
% c
ost
ofca
pita
l on
the
risk
cap
ital
(99.
5% q
uant
ile,
1-ye
ar).
Avi
vaM
CEV
9.90
%Sw
ap r
ates
31
Dec
embe
r 20
10C
FO/C
RO
For
um a
nd Q
IS 5
illiq
uidi
ty f
orm
ula
* (f
or t
he U
S bu
sine
ss x
= 6
0%)
• U
K:
109
• EU
R:
36•
US
imm
edia
te a
nnui
ties
: 66
• U
S ot
her:
56
Impl
ied
vola
tilit
y 31
Dec
embe
r 20
10,
exce
pt f
or p
rope
rty
vola
tilit
ies
whe
rebe
st e
stim
ate
leve
ls a
re u
sed.
Cap
ital
cha
rge
of 3
.3%
appl
ied
to g
roup
-div
ersi
fied
capi
tal.
AX
AEE
V
(Mar
ket
Con
sist
ent)
6.90
%Sw
ap r
ates
31
Dec
embe
r 20
10C
FO/C
RO
For
um a
nd Q
IS 5
illiq
uidi
ty f
orm
ula
*•
EUR
: 36
• G
BP:
79
• U
SD:
56•
JPY:
0•
CH
F: 8
• A
UD
: 65
Impl
ied
vola
tilit
y 31
Dec
embe
r 20
10A
llow
ance
for
non
-fin
anci
alri
sk a
ssum
ing
a hi
gher
lock
ed-in
cap
ital
bas
e(c
orre
spon
ding
to
loca
l AA
capi
tal r
equi
rem
ent)
.
Bal
oise
Gro
upM
CEV
No
t d
iscl
ose
dSw
ap r
ates
31
Dec
embe
r 20
10C
FO/C
RO
For
um a
nd Q
IS 5
illiq
uidi
ty f
orm
ula
*•
CH
F: 1
0 •
EUR
: 35
Im
plie
d vo
lati
lity
31 D
ecem
ber
2010
,ex
cept
for
pro
pert
y vo
lati
litie
s w
here
hist
oric
mar
ket
data
is u
sed.
A c
apit
al c
harg
e of
4%
isap
plie
d to
the
pro
ject
edSS
T ca
pita
l.
CN
PM
CEV
7.70
%Sw
ap r
ates
31
Dec
embe
r 20
10C
FO/C
RO
For
um a
nd Q
IS 5
illiq
uidi
ty f
orm
ula
*•
EUR
: 55
Impl
ied
vola
tilit
y 31
Dec
embe
r 20
10A
llow
ance
for
non
-fin
anci
alri
sk a
ssum
ing
a hi
gher
lock
ed-in
cap
ital
bas
e.
Gen
eral
iEE
V
(Mar
ket
Con
sist
ent)
6.99
%Sw
ap r
ates
31
Dec
embe
r 20
10(e
xcep
t fo
r C
zech
Rep
ublic
and
Isr
ael)
CFO
/CR
O F
orum
and
QIS
5 il
liqui
dity
for
mul
a *
• EU
R:
36
• C
HF:
8
• U
SD:
56
• G
BP:
79
Impl
ied
vola
tilit
y 31
Dec
embe
r 20
10A
llow
ed f
or a
s a
char
ge o
f4%
app
lied
to r
elev
ant
risk
-cap
ital
(le
ss t
ax).
Gro
upam
aEE
V
(Mar
ket
Con
sist
ent)
No
t d
iscl
ose
dTh
e ri
sk-f
ree
rate
cur
ve w
asco
nstr
ucte
d by
wei
ghti
ng t
hego
vern
men
t yi
eld
curv
es b
y th
eco
rres
pond
ing
prop
orti
ons
ofso
vere
ign
bond
s in
the
por
tfol
io,
tota
ke a
ccou
nt o
f th
e di
scre
panc
y at
31
Dec
embe
r 20
10 b
etw
een
the
spre
ad o
f th
e m
ain
gove
rnm
ent
debt
san
d th
eir
unde
rlyi
ng c
redi
t ri
sk.
The
calc
ulat
ion
met
hodo
logy
is b
ased
on
the
diff
eren
ce b
etw
een
two
indi
cato
rs:
–A
n in
dica
tor
of t
he s
prea
d on
the
bon
dm
arke
t, w
hich
the
refo
re in
clud
es t
heill
iqui
dity
dis
coun
t–
An
indi
cato
r ba
sed
on C
DS
prem
ium
s w
hich
does
not
incl
ude
this
dis
coun
t.Th
e liq
uidi
ty p
rem
ium
is a
mor
tise
d af
ter
15 y
ears
com
ing
to a
n en
d af
ter
20 y
ears
.
• EU
R:
16Im
plie
d vo
lati
lity
31 D
ecem
ber
2010
,ex
cept
for
pro
pert
y vo
lati
litie
s w
here
hist
oric
mar
ket
data
is u
sed.
Add
itio
nal r
isk
prem
ia o
f25
bps
and
50bp
s fo
rop
erat
iona
l ris
k an
dte
chni
cal r
isks
res
pect
ivel
yad
ded
to t
he C
oCca
lcul
atio
n.
KB
CM
CEV
No
t d
iscl
ose
dSw
ap r
ates
31
Dec
embe
r 20
10Li
quid
ity
prem
ium
s of
14b
ps a
re a
dded
to
the
risk
fre
e ra
tes
up t
o15
year
s an
d ar
e re
duce
dlin
earl
y to
zer
o ov
er t
he n
ext
five
yea
rs.
•14
up
to 1
5 ye
ars
•re
duce
d lin
earl
y to
zer
oov
er t
he n
ext
five
yea
rs
• B
elgi
um:
#N/A
• C
zech
Rep
ublic
& P
olan
d: I
mpl
ied
vola
tilit
y
Cap
ital
cha
rge
of 3
%ca
lcul
ated
bas
ed o
nin
tern
al e
cono
mic
cap
ital
.
Lega
l &G
ener
alEE
V#N
/A•
UK
RD
R =
7.3
%•
USA
RD
R =
6.6
%•
Euro
pe R
DR
= 6
.5%
#N/A
#N/A
Det
erm
ined
usi
ng m
arke
t da
ta a
ndsa
id t
o be
com
para
ble
to im
plie
dvo
lati
litie
s
#N/A
LBG
EEV
#N/A
•15
yea
r U
K g
ilt y
ield
for
non
-an
nuit
y bu
sine
ss•
An
equi
vale
nt s
ingl
e ri
sk f
ree
rate
for
annu
ity
busi
ness
bas
ed o
n U
Kgi
lt y
ield
cur
ve in
crea
sed
to a
llow
for
illiq
uidi
ty p
rem
ium
No
t d
iscl
ose
dN
ot
dis
clo
sed
Not
dis
clos
edN
ot d
iscl
osed
MCEV: At a turning point 17
Co
mp
any
Met
ho
do
log
yIm
plie
d D
isco
unt
Rat
e (I
DR
)R
efer
ence
Rat
esIll
iquid
ity
Pre
miu
ms
(Met
ho
do
log
y)Ill
iquid
ity
Pre
miu
ms
(Val
ue
in b
ps)
Vo
lati
litie
sC
RN
HR
Mun
ich
Re
MC
EVN
ot
dis
clo
sed
Swap
rat
es 3
1 D
ecem
ber
2010
(exc
ept
for
coun
trie
s w
here
mar
kets
are
not
deep
and
liqu
id)
No
allo
wan
ce f
or li
quid
ity
prem
ium
#N/A
Impl
ied
vola
tilit
y 31
Dec
embe
r20
10C
apit
al c
harg
e of
7%
. N
o al
low
ance
for
dive
rsif
icat
ion
betw
een
cove
red
and
non-
cove
red
busi
ness
.
Old
Mut
ual
MC
EVN
ot d
iscl
osed
Swap
rat
es 3
1 D
ecem
ber
2010
Onl
y al
low
for
it o
n tw
o pr
oduc
ts.
Met
hodo
logy
und
iscl
osed
• U
S: 7
5•
OM
SA’s
Ret
ail A
fflu
ent
Imm
edia
te A
nnui
ty:
45
Impl
ied
vola
tilit
y 31
Dec
embe
r20
10 f
or d
eep
and
liqui
dm
arke
t. H
isto
ric
data
and
expe
rt ju
dgm
ent
else
whe
re
Allo
wed
for
as
a ch
arge
of
2.9%
appl
ied
to t
he g
roup
div
ersi
fied
cap
ital
requ
ired
in r
espe
ct o
f su
ch n
on-
hedg
eabl
e ri
sks
Prud
enti
alEE
V#N
/AW
eigh
ted
RD
R:
• 8.
1% (
Asi
a),
• 6.
9% (
Jack
son)
, •
9.9%
(U
K a
nnui
ty)
• 7.
0% (
UK
oth
ers)
Top
dow
n ap
proa
chU
K a
nnui
ty:
92
Com
bina
tion
of
actu
al m
arke
tda
ta,
hist
oric
mar
ket
data
and
an a
sses
smen
t of
long
er-t
erm
econ
omic
con
diti
ons.
Allo
wed
as
a m
argi
n in
the
dis
coun
tra
te.
Def
ined
as:
• 10
0 bp
s fo
r U
K a
nnui
ty b
usin
ess
• 50
bps
for
Gro
up’s
oth
er b
usin
ess
• ad
diti
onal
100
to
250
bps
for
Gro
up's
Asi
an o
pera
tion
s
Res
olut
ion
MC
EVN
ot
dis
clo
sed
Swap
rat
es 3
1 D
ecem
ber
2010
Two
appr
oach
es u
sed:
1) A
com
pone
nt o
f th
e di
ffer
ence
bet
wee
nth
e sp
read
on
a co
rpor
ate
bond
and
acr
edit
def
ault
sw
ap;
and
2) U
se o
f op
tion
pri
cing
tec
hniq
ues
tode
com
pose
the
spr
ead
into
its
com
pone
nts
incl
udin
g ill
iqui
dity
pre
miu
m
UK
ann
uity
: 75
Mar
ket
impl
ied
vola
tilit
ies
Cap
ital
cha
rge
of 2
% o
n pr
ojec
ted
Gro
up r
equi
red
capi
tal f
or a
ll no
n-he
dgea
ble
risk
.
Stan
dard
Life
EEV
#N/A
RD
R =
ris
k fr
ee g
over
nmen
t bo
ndyi
eld
+ a
risk
mar
gin:
•
7.09
% (
UK
Her
itag
e W
PF)
• 6.
19%
(U
K o
ther
) •
6.89
% (
Can
ada)
• 6.
56%
(Eu
rope
Her
itag
e W
PF)
• 5.
66%
(Eu
rope
oth
er)
• Fo
r A
sia,
ris
k ne
utra
l app
roac
h an
dan
allo
wan
ce f
or n
on•m
arke
t ri
skw
as u
sed
#N/A
#N/A
Impl
ied
vola
tilit
y 31
Dec
embe
r20
10
Allo
wed
as
a m
argi
n in
the
dis
coun
tra
te.
Def
ined
as:
• 1.
80%
(U
K H
erit
age
WPF
) •
1.60
% (
UK
oth
er)
• 2.
80%
(C
anad
a)•
1.80
% (
Euro
pe H
erit
age
WPF
)•
1.60
% (
Euro
pe o
ther
) •
Not
dis
clos
ed f
or A
sia
Stor
ebra
ndM
CEV
Nor
way
: 8.
9%Sw
eden
: 10
.0%
Tota
l: 9.
2%
• M
arke
t in
tere
st r
ates
are
app
lied
toth
e liq
uid
part
of
the
inte
rest
rat
ecu
rve
up t
o 10
yea
rs•
A lo
ng-t
erm
equ
ilibr
ium
leve
l is
appl
ied
from
20
year
s an
d on
war
ds•
Line
ar in
terp
olat
ion
is u
sed
betw
een
10 y
ears
and
20
year
s
• N
o al
low
ance
for
liqu
idit
y pr
emiu
m#N
/AIm
plie
d vo
lati
lity
31 D
ecem
ber
2010
, ex
cept
for
pro
pert
yvo
lati
litie
s w
here
his
tori
cm
arke
t da
ta is
use
d.
Cap
ital
cha
rge
of 2
.5%
on
the
dive
rsif
ied
risk
cap
ital
for
non
-he
dgea
ble
risk
.
Swis
s Li
feM
CEV
No
t d
iscl
ose
dSw
ap r
ates
31
Dec
embe
r 20
10•
No
allo
wan
ce f
or li
quid
ity
prem
ium
#N/A
Impl
ied
vola
tilit
y 31
Dec
embe
r20
10,
exce
pt f
or p
rope
rty
vola
tilit
ies
whe
re h
isto
ric
mar
ket
data
is u
sed.
Cap
ital
cha
rge
of 4
% p
er a
nnum
has
been
app
lied
to t
he r
esul
ting
proj
ecte
d ca
pita
l at
risk
.
ZFS
MC
EVN
ot
dis
clo
sed
Swap
rat
es 3
1 D
ecem
ber
2010
• N
o al
low
ance
for
liqu
idit
y pr
emiu
m•
Will
incl
ude
liqui
dity
pre
miu
m in
the
201
1M
CEV
bas
ed o
n th
e C
FO/C
RO
For
um a
ndQ
IS 5
illiq
uidi
ty f
orm
ula
*
#N/A
Impl
ied
vola
tilit
y 31
Dec
embe
r20
10,
exce
pt f
or p
rope
rty
vola
tilit
ies
whe
re h
isto
ric
mar
ket
data
is u
sed.
• C
apit
al c
harg
e of
2.5
% a
pplie
d to
the
dive
rsif
ied
risk
cap
ital
• W
ill in
crea
se t
he c
apit
al c
harg
e fr
om2.
5% t
o 4%
in t
he 2
011
MC
EV
Sour
ce:
Com
pani
es’
disc
losu
re a
nd D
eloi
tte
anal
ysis
* C
FO/C
RO
For
um a
nd Q
IS 5
illiq
uidi
ty f
orm
ula:
LP
= M
AX
(0,
x%
× (
Spre
ad –
y b
ps))
Whe
re:
x =
50%
and
y =
40b
psLi
abili
ties
are
cla
ssif
ied
in 4
buc
kets
in f
unct
ion
of t
heir
nat
ure.
Dif
fere
nt p
ropo
rtio
ns o
f th
e LP
are
app
lied
(100
%,
75%
, 50
% a
nd 0
%)
MCEV: At a turning point 18
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