Embedded Value

Question 1

Reasons for analysing the change in Embedded Value: (9)

Answer 1

1. To assist in checking the calculation of the EV
2. To assist in the revision of assumptions by comparing actual experience against expected
3. To provide the management with the value of the new business written in the year
4. To identify the individual sources of EV profit and loss, and so indicate areas where management action may be desirable or required.
5. To identify unprofitable contracts so that they can be redesigned, re-priced or cancelled.
6. To improve management’s understanding of the business
7. To assist in the calculation of management incentive schemes
8. To provide investment analyst and the investing public with a more realistic picture of the true underlying sources of additional value creation.
9. To comply with APN 107

Question 2

The main components into which the change in ANW and VIF would be analysed are:

Answer 2

1. The value of new business written during the year
2. The difference between the actual and the expected transfer to/from the VIF from/to the ANW
3. This difference includes operating experience (from mortality, persitency, alterations, expenses) variances and investment return variances.
4. Any change in operating assumptions (e.g. Decrements and expenses)
5. Any model changes
6. Any economic assumption changes
7. Any data changes (e.g. model point changes)

Question 3

In the analysis of Change in EV - ANW will also change due to: (2)

(changes unique to ANW)

Answer 3

1. Investment return (income and capital appreciation/depreciation) on ANW.
2. Capital movements: Capital injections into the company and dividends paid out.

Question 4

MCEV applies financial economic principles in the following four steps: (4)

Answer 4

1. Options and guarantees are valued using standard option-pricing techniques, and with stochastic simulation in more complex cases.
2. Cash flows for products that do not contain any options or guarantees are valued using a discount rate, which reflects the risk inherent in each cash flow.
3. A deduction is made to compensate for the effect on shareholder value of double taxation.
4. An additional cost of capital is identified, helping shareholders to quantify agency risk.