Understanding Insurance Embedded Value: Definition, Calculation, and Examples

What is Insurance Embedded Value?

Insurance embedded value is a crucial valuation measure in the life insurance industry. It provides an estimate of the consolidated value of shareholders' interests. Embedded value takes into account the present value of future profits from existing policies, the value of assets, and liabilities. It helps insurance companies assess their financial strength and determine the worth of their business.

How Embedded Value Works

Embedded value is calculated by discounting projected future cash flows from insurance policies and subtracting the value of liabilities. This calculation involves complex actuarial techniques and takes into account various factors such as mortality rates, policy lapses, investment returns, and expenses. The resulting value represents the net worth of an insurance company's in-force business.

Example of Embedded Value

Let's consider an example to understand embedded value better. Suppose an insurance company has a portfolio of life insurance policies with a total sum assured of $1 billion. The projected cash flows from these policies over the next 20 years amount to $1.5 billion. The company's liabilities, including policy reserves and other obligations, are valued at $900 million. By discounting the projected cash flows and subtracting the liabilities, the embedded value of the insurance company would be $600 million.

Key Takeaways

• Insurance embedded value is a valuation measure used in the life insurance industry.
• It estimates the consolidated value of shareholders' interests.
• Embedded value is calculated by discounting projected future cash flows and subtracting liabilities.
• It helps insurance companies assess their financial strength and determine business worth.

What's the Difference Between Embedded Value and Enterprise Value?

While embedded value focuses on the net worth of an insurance company's in-force business, enterprise value encompasses the overall value of a company, including its equity and debt. Enterprise value takes into account factors like market capitalization, outstanding debt, and the value of non-insurance operations. Both measures play a significant role in assessing the financial standing and investment potential of insurance companies.

Why Do Insurance Companies Measure Embedded Value?

Insurance companies measure embedded value to gain insights into their financial performance, assess risks, and make strategic decisions. It helps them evaluate the profitability of their existing policies, identify areas of improvement, and allocate resources effectively. Furthermore, embedded value analysis provides valuable information to investors, analysts, and regulators, enabling them to evaluate the strength and stability of insurance companies.

The Bottom Line

Insurance embedded value is a fundamental metric for the life insurance industry. It provides a comprehensive assessment of an insurance company's value, considering present and future cash flows, assets, and liabilities. Understanding embedded value is essential for insurers, investors, and other stakeholders to make informed decisions regarding financial strength, profitability, and investment opportunities in the insurance sector.