Embedded Value (EV) is an actuarial valuation metric used primarily in life insurance to quantify the value of the business today, beyond what standard financial statements show. In simple terms, EV represents the consolidated value of the shareholders’ interests in the company. Equivalently, it can be viewed as the net asset value (capital and surplus) plus the present value of future profits from existing (in-force) policies, under best-estimate assumptions. Notably, EV excludes any value from future sales or new business.
Actuaries in Life Insurance companies perform a lot of activities. On of them is calculation of Embedded Value (EV).
For life insurance, where premiums and expenses span decades, EV provides a clearer picture of long-term profitability than single-period accounting metrics. It’s a core metric actuaries and insurers use to assess real economic value.
Key Components of Embedded Value
EV typically has two main components:
1. Adjusted Net Worth (ANW)
ANW is essentially the market value of the insurer’s assets minus its liabilities. It reflects the capital and surplus available to shareholders, usually excluding intangibles like goodwill3.
2. Value of In-Force (VIF) Business
This is the present value of future after-tax profits expected from policies already sold. Actuaries project these future cash flows (premiums, claims, expenses, investment returns) and discount them using a risk-adjusted rate4.
The formula generally looks like this:
EV = ANW + VIF
where VIF = Present Value of Future Profits (PVFP) – Present Value of Cost of Capital (PVCoC)
This cost of capital adjustment accounts for the regulatory capital insurers must hold, reducing the net distributable value.
How EV is Calculated
Calculating EV requires sophisticated actuarial models and well-thought-out assumptions. Here are the core building blocks:
- Best-Estimate Assumptions: Mortality, lapses, expenses, and investment return assumptions are set to reflect the most realistic expectations—no added conservatism or buffers5.
- Discount Rate: EV uses a Risk Discount Rate (RDR) to reflect the return shareholders require. Higher discount rates reduce the present value of future profits.
- Cost of Capital: This represents the cost of holding regulatory capital. It’s usually calculated as the difference between the RDR and the expected return on capital, applied over the capital held each year.
- Deterministic vs. Stochastic: Traditional EV uses deterministic cash flows. Market-consistent EV (MCEV) uses stochastic models to account for financial risk and embedded options.
Example: Embedded Value Calculation
Assumptions:
Let’s assume an insurance company has the following financials:
1. Adjusted Net Worth (ANW):
- Total assets (market value): ₹500 crore
- Total liabilities (excluding intangibles): ₹420 crore
- ANW = ₹500 crore – ₹420 crore = ₹80 crore
2. Value of In-Force (VIF) Business:
This is based on the projected after-tax future profits from current in-force policies.
Future Expected Profits:
| Year | Expected Profit (₹ crore) | Present Value Factor (at 10%) | PV of Profit (₹ crore) |
|---|---|---|---|
| 1 | 20 | 0.91 | 18.2 |
| 2 | 20 | 0.83 | 16.6 |
| 3 | 20 | 0.75 | 15.0 |
| 4 | 20 | 0.68 | 13.6 |
| 5 | 20 | 0.62 | 12.4 |
| Total PVFP | ₹75.8 crore |
Present Value of Cost of Capital (PVCoC):
Let’s assume:
- Required capital held each year = ₹20 crore
- Cost of capital (10% RDR – 5% investment return) = 5%
PVCoC = ₹20 crore × 5% × sum of present value factors = ₹20 × 0.05 × (0.91 + 0.83 + 0.75 + 0.68 + 0.62)
PVCoC ≈ ₹20 × 0.05 × 3.79 = ₹3.79 crore
3. Final Embedded Value Calculation:
EV = ANW + (PV of Future Profits – PV of Cost of Capital)
EV = ₹80 crore + (₹75.8 crore – ₹3.79 crore)
EV = ₹80 crore + ₹72.01 crore = ₹152.01 crore
Interpretation:
The embedded value of ₹152.01 crore tells us that if the company wrote no more new business, this is the expected value to shareholders from existing policies plus current net worth, discounted for risks and cost of capital.
Why Embedded Value Matters
EV is more than just a theoretical model. Here’s how it’s used:
1. Internal Management
Companies use EV to guide strategic decisions, capital allocation, and executive performance metrics. It tells management where long-term value is being created (or destroyed)1.
2. Investor & Analyst Communication
EV provides a more comparable and consistent way to judge value, especially across international insurers. It helps fill the gaps that GAAP or statutory accounting often leave open6.
3. Mergers & Acquisitions
In M&A, Embedded Value is the foundation for actuarial appraisals. Unlike EV, appraisals do include expected value from future new business—so they typically exceed EV. But the modeling principles are similar.
4. Capital Insights
While not a regulatory metric, EV complements capital assessments. It distinguishes between free surplus, required capital, and future distributable profits.
Regional Differences in Embedded Value Practice
EV is widely adopted in Europe and Asia, but less so in North America.
Europe
European insurers follow standardized guidance from the CFO Forum, which developed the European Embedded Value (EEV) and later the Market Consistent Embedded Value (MCEV) principles7. These frameworks ensure that large insurers report EV with consistent assumptions and disclosures.
Asia-Pacific
In Asia, major insurers like AIA and Prudential publish detailed EV disclosures. Japanese insurers helped shape MCEV standards and regularly use them for market comparisons.
United States & Canada
EV is rarely published in North America. U.S. and Canadian companies focus on GAAP or statutory reporting and Risk-Based Capital (RBC). However, EV may still be used internally for valuation or long-term strategy.
EV vs. IFRS 17
The rollout of IFRS 17 in 2023 brings new reporting rules for insurance liabilities and profits. While IFRS 17 introduces components like the Contractual Service Margin (CSM) and Risk Adjustment, it doesn’t replace EV10.
EV continues to provide a shareholder-centric view of value, while IFRS 17 focuses on profit emergence over time. Some elements (e.g., cash flow modeling, risk adjustments) are shared, but the intent and output of the two frameworks differ.
The Future of Embedded Value (EV) in Life Insurance
With digital transformation and real-time modeling capabilities, we can expect EV to evolve. Trends include:
- Greater alignment with IFRS 17 and solvency regulations.
- Use of AI and advanced analytics for assumption setting.
- Demand for more frequent and transparent EV disclosures.
While IFRS 17 and Solvency II may reshape external reporting, EV is here to stay—especially as a strategic and valuation tool for actuaries and insurers worldwide.
Footnotes
- American Academy of Actuaries. What is Embedded Value?
- Milliman. Embedded Value Overview
- SOA. Embedded Value Basics
- Deloitte. Embedded Value & IFRS 17
- KPMG. Life Insurance EV Modelling
- PwC. Appraisal Valuations vs EV
- CFO Forum. MCEV Principles
- AIA Group. Disclosure
- American Academy of Actuaries. North America
- Deloitte. EV vs IFRS 17