An embedded value (EV) is a common valuation measure used largely by life insurance companies outside North America to estimate the consolidated value of shareholders' interest in an insurance company. It is calculated by adding the present value of future profits of a firm to the net asset value of capital and surplus. The present value of future profits captures projected future profits from in-force policies, while net asset value of capital and surplus represents the funds belonging to shareholders that have been accumulated in the past.
Breaking down Embedded Value
The embedded value is a standard valuation metric for European life insurers. It is not mandated by the regulatory authorities there, but it has become an industry norm for an insurer to track EV components and manage them to increase the value of the company. With this established standard analysts can study the numbers and make comparisons across the sector. EV serves as a performance metric, a basis for M&A deals, and the basis for executive compensation plans. Very few North American firms currently utilize EV, but some industry consultants believe they can benefit from tracking and reporting it, at least internally.
Importance of Embedded Value
As an example of the importance of EV to European insurers, one can look at Zurich Insurance Group's annual report(s) on embedded value. The 33-page report for 2016 contains an executive summary, an analysis of embedded value earnings and value of business in-force, sensitivities, reconciliation of shareholders' equity to embedded value, the regional analysis of embedded value, methodology, assumptions, a statement by directors and an auditor's report on embedded value.