Introduction to Market Consistent Embedded Values Rokas Gylys Lithuanian Actuarial Association

Contents What is embedded value? Key components of MCEV Comparison EEV and MCEV Interaction of Solvency II and IFRS Discussion

What is EV? EV = Value of shareholders’ net assets + present value of net transfers to shareholders from in force business EV profit = change in EV + net transfers to shareholders (dividends) EV is expected to show a more realistic financial position and results of operations of an insurance company than current statutory regimes Companies started to report in 1989, but lack of consistency initially In 2004 European Embedded Value (EEV) principles were published by European Insurance CFO Forum 4th June 2008 - CFO Forum published Market Consistent EV (MCEV) principles

Why Embedded Value Reporting? Local statutory measures of profit make a growing company look like it is destroying value

Calculating an EV

MCEV – Components The MCEV consists of the following components: Free surplus allocated to the covered business Required capital; and Value of in-force covered business (VIF) The VIF consists of the following components: Present value of future profits (PVFP); less Time value of financial options and guarantees Frictional costs of required capital Cost of residual non-hedgeable risks

MCEV – Components Free surplus is the market value of any assets allocated to, but not required to support, the in-force covered business at the valuation date Required capital = MAX (Solvency capital, economic capital) Present value of future profits are post-taxation shareholder cash-flows from the in-force covered business and the assets backing the associated liabilities Time value of options and guarantees: Need to allow for financial asymmetries Market consistent methodology: usually stochastic approach is required for valuation Allowance for dynamic policyholder actions and management discretion

MCEV – Components (2) Frictional costs of required capital Double taxation, investment expenses, any policyholder participation on returns for assets required to back required capital Required capital at the greater of regulatory requirement or company target level Cost of residual non-hedgeable risks Insurance, operational, and other non-hedgeable risks disclosed through change on economic capital required for those risks

Key features of MCEV A shareholder’s perspective on value: the present value of future cash-flows available to the shareholder, adjusted for the risks of those cash-flows Not taking any credit for any future investment return in excess of risk-free rates Reflecting the current market price of hedging financial risks With a transparent (?) allowance for non-hedgeable risks Reflecting the actual and expected experience of the specific business MCEV will be volatile if investment markets are volatile

MCEV – Comparison to EEV

Interaction with Solvency II and IFRS

Discussion Any questions or comments?

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