1. Introduction to Market Consistent Embedded Values
Rokas Gylys
Lithuanian Actuarial Association

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

3. 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 CFO Forum published Market Consistent EV (MCEV) principles

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

5. Calculating an EV

6. 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

7. 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

8. 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

9. 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

10. MCEV – Comparison to EEV

11. Interaction with Solvency II and IFRS

12. Discussion
Any questions or comments?

13. THANK YOU!