Embedded Value Calculator
Use this calculator to estimate the Embedded Value (EV) of an insurance business. Embedded Value is a key metric used to assess the value of life insurance companies, representing the sum of the Net Asset Value (NAV) and the present value of future profits from existing business (Value of In-Force).
Calculation Results:
Enter values and click "Calculate" to see the results.
Understanding Embedded Value (EV) in Insurance
Embedded Value (EV) is a crucial financial metric predominantly used in the life insurance industry to assess the value of a company. Unlike traditional accounting measures that focus on historical performance, EV provides a forward-looking estimate of the value generated by the existing business. It's particularly important for life insurers because a significant portion of their value comes from long-term contracts (policies) that generate profits over many years.
Components of Embedded Value
Embedded Value is typically broken down into two main components:
- Net Asset Value (NAV) of Shareholder Funds: This represents the value of assets held by the company that are not required to back policyholder liabilities. It includes shareholder capital, reserves, and any free surplus. Essentially, it's the tangible net worth of the company's existing assets.
- Value of In-Force (VIF) Business: This is the present value of future profits expected to emerge from the existing portfolio of insurance policies. These profits are discounted back to the present day using a risk-adjusted discount rate, reflecting the time value of money and the inherent risks associated with future cash flows. The VIF captures the economic value of the long-term contracts already on the books.
The formula for Embedded Value is straightforward: Embedded Value = Net Asset Value + Value of In-Force.
Why is Embedded Value Important?
- Valuation Tool: EV is a primary metric for valuing life insurance companies, especially during mergers, acquisitions, or for investors looking to understand the true economic worth beyond statutory accounting.
- Performance Measurement: It helps management and investors track the creation of value over time, providing insights into the profitability and efficiency of the existing business.
- Strategic Planning: By understanding the drivers of EV, companies can make better strategic decisions regarding product development, pricing, and capital allocation.
- Transparency: EV provides a more transparent view of an insurer's financial health and future prospects compared to traditional accounting, which can sometimes obscure the long-term nature of insurance liabilities and assets.
Key Inputs Explained
- Shareholder Capital & Reserves: This is the capital directly contributed by shareholders and accumulated earnings retained by the company, forming a buffer against unexpected losses and supporting new business.
- Free Surplus: These are assets held by the company that are not required to meet regulatory capital requirements or policyholder liabilities. It represents readily available capital that can be deployed for growth or returned to shareholders.
- Expected Annual Future Profits: This is an estimate of the average annual profit that the existing block of insurance policies is expected to generate over its remaining lifetime, after accounting for claims, expenses, and taxes.
- Profit Duration (Years): This refers to the estimated number of years over which the existing policies are expected to generate these future profits. It's a critical factor in determining the total future cash flows.
- Discount Rate (%): This is the rate used to convert future profits into their present-day equivalent. It reflects the time value of money and the risk associated with receiving those future profits. A higher discount rate implies higher perceived risk or opportunity cost, leading to a lower present value.
Example Calculation
Let's consider a hypothetical insurance company with the following figures:
- Shareholder Capital & Reserves: $500,000,000
- Free Surplus: $100,000,000
- Expected Annual Future Profits: $75,000,000
- Profit Duration: 15 years
- Discount Rate: 8%
Using these inputs:
- Net Asset Value (NAV): $500,000,000 (Shareholder Capital) + $100,000,000 (Free Surplus) = $600,000,000
- Value of In-Force (VIF):
Using the present value of an annuity formula:
VIF = $75,000,000 * [ (1 – (1 + 0.08)^-15) / 0.08 ]
VIF = $75,000,000 * [ (1 – 0.31524) / 0.08 ]
VIF = $75,000,000 * [ 0.68476 / 0.08 ]
VIF = $75,000,000 * 8.5595
VIF = $641,962,500 - Total Embedded Value (EV):
EV = NAV + VIF
EV = $600,000,000 + $641,962,500
EV = $1,241,962,500
This example demonstrates how the calculator combines the tangible assets with the discounted value of future profits to arrive at a comprehensive valuation of the insurance business.