Using Embedded Values to Value a Life Assurance Company

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Using Embedded Values to Value a Life

Assurance Company

Craig Falconer

Chair of Africa Committee

Second African Congress of Actuaries

Nairobi, Kenya

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Contents

• Introduction

• Uses of Embedded Values

• Embedded Values

• Appraisal Value

• Value of Future New Business

• Major Challenges

• Concluding Comments

• Questions

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Uses of Embedded Values

• Companies need valuations for various reasons:

− Determining share price when undertaking a listing

− Mergers and Acquisitions

− Ongoing monitoring of company performance by management, shareholders and

industry analysts

− Used for setting management’s bonus incentives i.e. by placing notional internal

value on a company

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Embedded Values Components

Free Surplus;

Plus,

Required Capital; plus,

Value of In-force

business less

Cost of Required Capital (CoC)

Cost of Surplus

Restriction

Adjusted Net Worth

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Embedded Values

• EV = discounted value of future s/h profits on existing business plus NAV less capital

costs

• Ignores future new business

• Many companies include EV in AFS

• EV earnings better measure for company performance than I/S

− New business strain

− Prudent Reserving

− Solvency Capital

• Embedded Value reporting standards

− Traditional EV

− European Embedded Value

− Market Consistent EV

− SA PGN107

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Appraisal Value

• Goodwill needs to be added to Embedded Value to arrive at Appraisal Value

• Depends on company’s infrastructure, quality of staff and effectiveness of

policies/procedures as well as managements’ ability to attract future new business

• Quantified by calculating the Value of Future New Business

• AV = EV + Value of Future New Business

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Value of Future New Business

• Subjective

• Two approaches:

− Use of value of new business multipliers

− Project expected new business cash flows

• Take into account Management view and budgets

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Value of Future New Business (cont..)

• Challenges in determining suitable value:

− Management budgets usually aggressive

− ….also suitable for setting business targets may not be suitable for AV

− For newly established companies, value of new business often negative because

of high relative expenses

− Sensitive to regulatory changes, competition and economic environment

− Need to find balance to determine realistic long-term new business growth

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Advantages of EV’s and AV’s

• EV accepted starting point in setting a price

• EV a proxy for share price

− Share price ≈ EV / (number of shares)

• Published EV’s provide more relevant information to potential investors and analysts

• More accurate reflection of performance than published I/S

• Adds more stability to share price

• Provides useful ratios i.e. Return on EV

− RoEV = EV earnings / EV start of year

• EV more accurate / objective than other methods of determining share price:

− i.e. Compare share price to multiple of earnings

• Published EV discloses Value of New Business

− Shows new business profitability

• More information

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Challenges

• Balancing stakeholders

• Determining suitable Risk Discount Rate

− SA market currently trading at discount to EV

• Regulations and tax legislation e.g.

− Restriction on shareholder transfers e.g. currently in Kenya 30% restriction on

shareholder transfers from Life Fund

− Deferred Tax

− Solvency Capital Requirements

− Solvency II…

• Best estimate assumptions.

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

SA Companies – Key indicators

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Concluding Comments

• EV’s are widely used

• Many uses

• Here to stay for a while in Africa

• Countries adopting Solvency II?

ACTUARIAL SOCIETY – Quantifying risk, enabling opportunity

Questions