Embedded Value Analysis for Life Insurance

Understanding Embedded Value

Embedded value (EV) is a measure of the economic value of a life insurance company. It consists of two components: adjusted net worth (the market value of assets backing surplus) and the value of in-force business (VIF), which represents the present value of future after-tax distributable earnings from existing policies. Unlike statutory or GAAP accounting, which can obscure economic reality through reserve and DAC mechanics, embedded value attempts to capture the true economic profit embedded in the current book of business. It is widely used outside the United States and increasingly adopted for internal management purposes domestically.

Calculation and Application

Computing embedded value requires projecting premiums, claims, expenses, investment income, and taxes for all in-force policies over their remaining lifetimes and discounting the resulting distributable earnings at a risk-adjusted discount rate. Market consistent embedded value (MCEV) uses market-consistent assumptions for financial risks, incorporating the cost of financial options and guarantees. Actuaries use EV analysis for performance measurement, strategic planning, merger and acquisition pricing, and management compensation. Changes in EV from period to period are decomposed into sources (new business value, experience variances, assumption changes, market movements) to understand business performance drivers.