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1 2003 Deloitte & Touche LLP 2 2005 Deloitte Advisory Sp. z o.o.
2 3
COMPONENTS OF THE
EMBEDDED VALUE
1
Traditional Embedded Value Adjusted Net Asset
Value
3 2005 Deloitte Advisory Sp. z o.o. 4 2005 Deloitte Advisory Sp. z o.o.
Hidden
Expected
Undis-
actuarial closed future net
Hidden Hidden
reserves* reserves*
reserves surplus profits
Discounting at
Assets Liabilities Adjusted Share of Tax Adjusted risk discount
Asset hidden Net rate
Value reserves Asset NPVFP
NPVFP
* In bonds, stocks and real estate Value
allocated
(ANAV)
5 to NPVFP 2005 Deloitte Advisory Sp. z o.o. 6 2005 Deloitte Advisory Sp. z o.o.
1
COST OF CAPITAL 3
Policyholders
Required part
capital for Shareholders
part
inforce
business ...
(EU solvency
margin) Year Year Year Year ... Year
1 2 3 4 n
((Earned
Earned rate
rate risk
Shareholders
Shareholders part
risk discount
part of
discount rate)
of required
rate) xx
required capital
capital
Capital charge
European Embedded Value
Capital
...
charges
Discounting at
risk discount rate
Cost
Cost of
of ...
Capital
Capital
7 2005 Deloitte Advisory Sp. z o.o. 8 2005 Deloitte Advisory Sp. z o.o.
CFO Forum
9
WWW.CFOFORUM.NL 2005 Deloitte Advisory Sp. z o.o. 10 2005 Deloitte Advisory Sp. z o.o.
CFO Forum
THE EUROPEAN EMBEDDED VALUE CONCEPT
2
What are the key challenges Time value of options and guarantees
How do we calculate the fourth component the time value of options The benefits written in participating life insurance business have an option-like
and guarantees? pay off profile
They have a floor (the guarantees provided)
They have an upside (future bonus decisions)
How do we set an economic basis that is consistent throughout the
calculations? So it is appropriate to use option based techniques to value these contracts
How do set the risk discount rate now that we have explicitly allowed If they were simple pay off structures we could use a technique like Black
for a large portion of the risk? Scholes to achieve this
Unfortunately they are not and we are pushed in the direction of more
How do we present the result?
sophisticated techniques like stochastic valuation
Using a stochastic valuation technique we can calculate a value for the options
and guarantees (time and intrinsic value) of the business written
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3 2 4 5
1 6 Have we taken care of all of the risks, in particular the non financial
risks?
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The intrinsic value of an option is based upon the risk free yield curve
3 2 4 5
In our first calculation we have time and intrinsic combined 1 6
17 2005 Deloitte Advisory Sp. z o.o. 18 2005 Deloitte Advisory Sp. z o.o.
3
One of the four pieces
Operational Steps for Implementing the EEVP
Now we have the time value of the options and guarantees, we just do
our traditional EV and we are finished?
3 2 4 5
1 6
Yes, but.
19 2005 Deloitte Advisory Sp. z o.o. 20 2005 Deloitte Advisory Sp. z o.o.
I have goal seeked to get a risk discount rate for my embedded value
basis
3 2 4 5
1 6
Does it capture all of the risks that I want?
3 2 4 5
1 6
Step 1: Step 3: Step 2: Step 4: Step 5: Step 6: Market Consistent Embedded Value
EV based on = (2) (1) EV based on = (2) = (5) (4) Traditionally = (3) = (5) (3)
market con- Time value of pure risk free Traditionally Reduction calculated Time value of EEVP
sistent valua- financial op- roll up. calculated due to use of EV, financial op- conform EV.
tion of finan- tions and EV, increased risk but with an tions and
cial options gua- but with an discount rate. risk discount gua-
and guaran- rantees. risk discount rate greater rantees.
tees. rate greater the one used
than risk free in Step 4 in
that reprodu- order to incor-
ces the value porate a mar-
of Step 2. gin for other
risks than
those from
financial
options and
23 guarantees. 2005 Deloitte Advisory Sp. z o.o. 24 2005 Deloitte Advisory Sp. z o.o.
4
Market consistent valuation
25 2005 Deloitte Advisory Sp. z o.o. 26 2005 Deloitte Advisory Sp. z o.o.
Prophet - Life provides a fast, friendly and flexible solution for At the October 2005 SunGard purchased Prophet system and the life
actuaries involved in life assurance, permanent health insurance and libraries from Deloitte
insured pension products. It manages the calculations and financial The main rationale for the sale was regulatory
models used for:
SunGard can offer clients a significant improvement in the IT field of
Prophet.
Embedded and appraisal valuations
Deloitte will be continuing to use Prophet in all its consultancy work
Cash flow and financial projections
and will be continuing to provide implementation and other services
Net premium, gross premium and discounted cash flow valuations around Prophet to clients.
Realistic earnings valuations and reporting (including achieved profits, US
GAAP and Margin on Services) More information - http://www.prophet-web.com
Asset/liability modelling
Dynamic solvency testing
Stochastic projections
Surplus and bonus strategy analyses
Product pricing and design
Analysis of surplus and movement in embedded values
27 2005 Deloitte Advisory Sp. z o.o. 28 2005 Deloitte Advisory Sp. z o.o.
Questions?