Embedded Value Calculation

Understand the intrinsic worth of an insurance business with our comprehensive Embedded Value calculator and guide.

Embedded Value Calculator

Embedded Value Calculation Inputs & Assumptions

Input/Assumption	Value	Unit	Description
Current Assets		Currency	Total assets held.
Liabilities		Currency	Total financial obligations.
Projected Future Profits (PV)		Currency	Present value of future profits from existing policies.
Cost of Capital		%	Required rate of return.
New Business Margin		%	Profit margin on new policies.
New Business Volume		Currency	Value of new policies written.

Summary of the key inputs and assumptions used in the embedded value calculation.

What is Embedded Value?

Embedded Value (EV) is a crucial metric used primarily in the insurance industry to assess the intrinsic worth of a life insurance company. It represents the present value of all future profits expected to be generated from the existing book of business, plus the net worth of the company. Essentially, it's an estimate of what the company's current business is worth today, independent of any future new business.

The embedded value calculation provides a standardized way to value insurance companies, making it invaluable for mergers, acquisitions, solvency assessments, and performance evaluations. It focuses on the value derived from the in-force policies, which are the company's most stable and predictable revenue streams.

Who Should Use It?

The primary users of embedded value calculations are:

• Insurance Companies: For internal valuation, strategic planning, and reporting to shareholders.
• Investors and Analysts: To value insurance companies for investment purposes, comparing different entities within the sector.
• Regulators: To assess the financial health and solvency of insurance providers.
• Acquirers and Sellers: During mergers and acquisitions to determine a fair purchase price.

Common Misconceptions

Several misconceptions surround embedded value:

• EV is the total market value: EV only reflects the value of existing business. It does not include the value of future new business, brand value, or other intangible assets not directly tied to in-force policies.
• EV is static: EV is a dynamic figure that changes with market conditions, interest rates, mortality experience, and the company's operational performance.
• EV is a guarantee: EV is based on projections and assumptions. Actual future profits may differ significantly.

Embedded Value Formula and Mathematical Explanation

The core embedded value formula is a sum of two main components: the net worth of the company and the present value of future profits from the existing business.

The Formula:

Embedded Value (EV) = Net Worth + Present Value of Future Profits (PVFP)

Let's break down each component:

1. Net Worth

Net Worth represents the company's financial strength at a specific point in time. It is calculated as:

Net Worth = Current Assets – Liabilities

• Current Assets: All assets owned by the company that can be readily converted to cash.
• Liabilities: All financial obligations the company owes to others.

2. Present Value of Future Profits (PVFP)

This is the most complex part of the EV calculation. It represents the discounted value of all future profits expected from the in-force policies. This calculation involves projecting future cash flows from these policies (premiums less claims, expenses, and taxes) and discounting them back to their present value using an appropriate discount rate, often referred to as the cost of capital or required rate of return.

For simplicity in many calculators, PVFP is often provided as a single input. However, a more detailed calculation would involve actuarial modeling.

Value of New Business (VONB)

While not strictly part of the core EV formula, the Value of New Business (VONB) is a critical related metric, especially for performance analysis and acquisition valuation. It represents the present value of future profits expected from policies written in a specific period.

VONB = New Business Volume * New Business Margin (expressed as PV)

Our calculator includes VONB as a component to provide a more holistic view, often considered in acquisition scenarios where the acquirer values both the existing book and the potential for growth.

Variable Explanations

Variable	Meaning	Unit	Typical Range
Current Assets	Total assets owned by the company.	Currency	Varies widely based on company size.
Liabilities	Total financial obligations.	Currency	Varies widely based on company size.
Projected Future Profits (PV)	Present value of future profits from existing policies.	Currency	Can be millions to billions.
Cost of Capital	Required rate of return for investors; discount rate.	%	5% – 15% (depends on risk and market).
New Business Margin	Profit margin on new policies sold.	%	2% – 10% (varies by product and market).
New Business Volume	Total value of new policies written.	Currency	Varies widely based on company size and market penetration.
Net Worth	Equity of the company (Assets – Liabilities).	Currency	Positive value indicates solvency.
Value of New Business (VONB)	Present value of profits from new policies.	Currency	Can be significant for growth-oriented insurers.
Embedded Value (EV)	Total intrinsic value of the company based on existing business.	Currency	Sum of Net Worth and PVFP.

Practical Examples (Real-World Use Cases)

Example 1: Valuation for Acquisition

An established insurance company, "SecureLife Insurers," is considering acquiring a smaller competitor, "Reliable Policies Ltd." To determine a fair offer price, they need to calculate the Embedded Value of Reliable Policies Ltd.

Inputs for Reliable Policies Ltd.:

• Current Assets: 150,000,000
• Liabilities: 100,000,000
• Projected Future Profits (PV): 200,000,000
• Cost of Capital: 12%
• New Business Margin: 6%
• New Business Volume: 50,000,000

Calculation:

• Net Worth = 150,000,000 – 100,000,000 = 50,000,000
• Value of New Business (VONB) ≈ 50,000,000 * 6% = 3,000,000 (simplified; actual VONB calculation is more complex)
• Embedded Value (EV) = 50,000,000 (Net Worth) + 200,000,000 (PVFP) = 250,000,000

Interpretation: The Embedded Value of Reliable Policies Ltd. is 250,000,000. This forms a baseline for SecureLife Insurers' offer. They might also consider the VONB as an indicator of future growth potential. The acquisition price would likely be negotiated around this EV figure, potentially adding a premium for strategic value or synergies.

Example 2: Performance Measurement

"Guardian Assurance" wants to assess its performance over the last fiscal year. They use the EV calculation to see how the value of their existing business has changed.

Inputs at Year-End:

• Current Assets: 800,000,000
• Liabilities: 600,000,000
• Projected Future Profits (PV): 1,200,000,000
• Cost of Capital: 10%
• New Business Margin: 5%
• New Business Volume: 300,000,000

Calculation:

• Net Worth = 800,000,000 – 600,000,000 = 200,000,000
• Embedded Value (EV) = 200,000,000 (Net Worth) + 1,200,000,000 (PVFP) = 1,400,000,000

Interpretation: Guardian Assurance's Embedded Value is 1.4 billion. By comparing this to the EV at the beginning of the year, management can gauge the growth in the value of their in-force business. An increase in EV suggests effective management of existing policies and potentially favorable market conditions or improved operational efficiency. The VONB of 15,000,000 (300M * 5%) also indicates the contribution of new sales to future value.

How to Use This Embedded Value Calculator

Our calculator simplifies the complex process of estimating Embedded Value. Follow these steps for accurate results:

1. Gather Data: Collect the required financial figures for the insurance entity you are valuing. This includes current assets, liabilities, the present value of future profits from existing policies, and details about new business.
2. Input Values: Enter the figures into the corresponding fields in the calculator. Ensure you use consistent currency units. For percentages (Cost of Capital, New Business Margin), enter the number (e.g., 10 for 10%).
3. Review Assumptions: Note the assumed Cost of Capital and New Business Margin. These are critical drivers of the EV and VONB.
4. Calculate: Click the "Calculate Embedded Value" button.
5. Interpret Results: The calculator will display the Net Worth, Value of New Business (VONB), and the final Embedded Value (EV). The main result highlights the EV.
6. Analyze Components: Examine the intermediate results (Net Worth, VONB) and the chart to understand the breakdown of the company's value.
7. Save/Copy: Use the "Copy Results" button to save the key figures and assumptions for your reports or further analysis.

Decision-Making Guidance: A higher EV generally indicates a more valuable company based on its existing operations. When comparing companies, EV provides a standardized metric. For acquisitions, EV is a key negotiation point. For internal performance, tracking EV growth over time is essential. Remember that EV is a point-in-time estimate and relies heavily on the accuracy of the underlying assumptions.

Key Factors That Affect Embedded Value Results

Several factors significantly influence the calculation and final result of Embedded Value:

• Interest Rates (Discount Rate): The Cost of Capital (discount rate) used to calculate the Present Value of Future Profits (PVFP) has a profound impact. Higher interest rates lead to a lower PVFP, thus reducing the EV. Conversely, lower rates increase PVFP and EV. This is a critical assumption.
• Mortality and Morbidity Experience: If actual claims experience (deaths or illnesses) is lower than projected, future profits will be higher, increasing EV. Conversely, higher-than-expected claims reduce profits and EV.
• Policyholder Behavior: Lapses (policy cancellations) and surrenders (policy withdrawals) can affect future cash flows. Higher-than-expected lapses can reduce future profits, while lower lapses can increase them.
• Operational Efficiency and Expenses: Lower operating expenses (commissions, administration) lead to higher profits, thereby increasing EV. Efficient management is key.
• New Business Growth and Profitability: While EV focuses on existing business, the Value of New Business (VONB) is closely watched. Strong new business performance, reflected in a higher New Business Margin and Volume, indicates future growth potential and can influence investor sentiment and acquisition premiums.
• Regulatory Environment and Taxes: Changes in regulations or tax laws can impact profitability and the present value of future cash flows, thereby affecting EV. Solvency requirements also influence capital allocation.
• Economic Conditions: Broader economic factors like inflation, economic growth, and market performance affect investment returns on assets and the overall profitability of the insurance business.

Frequently Asked Questions (FAQ)

Q1: Is Embedded Value the same as Shareholder Equity?
A1: No. Shareholder Equity (or Net Worth in our calculator) is a balance sheet figure representing historical accounting value. Embedded Value is a forward-looking valuation metric that includes the present value of future profits from existing business, which is not reflected on the balance sheet.

Q2: How often should Embedded Value be calculated?
A2: Insurance companies typically calculate EV quarterly or annually for financial reporting and performance monitoring. It should also be recalculated whenever significant assumptions change or for specific events like M&A.

Q3: What is the difference between EV and EV at completion?
A3: EV at completion (EVC) is a more refined measure used in M&A. It adjusts the standard EV for the expected costs and timing of closing the transaction, providing a clearer picture of the net value received by the seller or paid by the buyer.

Q4: Can Embedded Value be negative?
A4: While uncommon for established insurers, EV could theoretically be negative if liabilities significantly outweigh the present value of future profits and net worth. This would indicate severe financial distress.

Q5: How does the Cost of Capital affect EV?
A5: A higher Cost of Capital (discount rate) reduces the present value of future profits, thus lowering the EV. A lower Cost of Capital increases the PVFP and EV. It reflects the risk associated with achieving those future profits.

Q6: Does EV include the value of future new business?
A6: No, the core Embedded Value calculation is based *only* on the existing book of business. The value of future new business is measured separately, often as the Value of New Business (VONB).

Q7: What are the limitations of EV calculations?
A7: EV relies heavily on actuarial assumptions about future experience (mortality, expenses, interest rates). These assumptions are inherently uncertain, making EV an estimate rather than a precise figure. It also doesn't capture all intangible assets like brand value or management quality directly.

Q8: How is EV used in solvency calculations?
A8: EV provides insight into the underlying profitability of the business. While not a direct solvency measure itself (which focuses on available capital vs. required capital), a strong EV suggests a healthy, profitable business that is better positioned to meet its long-term obligations.