EV of Canadian Group Insurance

Question 1

Formulas for calculating embedded value (2)

Answer 1

For a block of business:

1. Embedded value = PV(after-tax profits) + cost of capital
2. Cost of capital = PV(future tied capital releases minus increases) + PV(after-tax income earned on tied capital) - tied capital

For the company as a whole:
1. Embedded value = PV(after-tax profits) + cost of capital + tied capital + free capital = PV(after-tax profits) - PV(increase in locked-in capital) + PV(after-tax investment income on capital) + free capital

Question 2

Uses of embedded value for a block of business (5)

Answer 2

1. To set a value on a block of business for sale or purchase
2. As a part of the calculation of the value of a company. The company’s value would also include the value of future new business.
3. To ensure that new business sold is generating an increase in value
4. To determine compensation for sales staff
5. To measure the impact of specific management actions on the long-term value of the company