Embedded Value
Contents
Deciphering Embedded Value: A Key Metric in Insurance Industry
Understanding Embedded Value
Embedded value (EV) stands as a pivotal metric in the evaluation of insurance companies, particularly prevalent in European markets. Unlike North America, where its adoption remains limited, EV serves as a vital tool for estimating the consolidated value of shareholders' interest in insurance firms. This comprehensive measure combines the present value of future profits with the net asset value (NAV) of a company's capital and surplus.
The Significance of Embedded Value
European insurers, such as Zurich Insurance Group, meticulously track and report on embedded value in their annual reports. This practice underscores the importance of EV as a performance metric, influencing executive compensation plans and serving as a basis for M&A decisions. Analysts leverage EV to conduct sector-wide comparisons, facilitating informed decision-making and strategic planning.
Methodology and Application
The methodology behind embedded value entails a meticulous bottom-up market-consistent approach, accounting explicitly for market risks. Asset and liability cash flows are meticulously valued using risk discount rates aligned with capital market standards, while options and guarantees are assessed using market-consistent models calibrated to observable market prices. Despite limited adoption in North America, industry experts advocate for its internal tracking and reporting for enhanced performance evaluation.