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NPV vs other metrics e.g. VNB

E

Einstein1

Member
Is NPV (net present value) i.e. Discounted future cash flows the same as VNB (value of new business) which I thought was also all future cash flows discounted. What is the difference if any? Does one not allow for cost of capital and the other does or similar?
Thanks!
 
NPV is a general term used to describe the method of valuing a series of cashflows. We might be discounting cashflows for a capital project, or valuing cashflows for insurance business (and in the latter case, we might be valuing cashflows for an individual policy, for all our existing business, for new business etc). We might be including just physical cashflows eg premiums, claims, expenses, or we might also include notional cashflows, such as setting up reserves.

Calculating the value of new business is a very specific task. So we would use an NPV approach to calculate the value of new business.
 
As Anna said NPV is a general methodology of calculating the value of a stream of cashflows. The VNB is a specific calculation that uses an NPV methodology.

As I understand your question, you want to know the difference in assumptions between the NPV criteria used in profit testing and in the VNB calculation. If I am wrong about this, just ignore the rest of my message.

As I understand it...

...the NPV calculation in profit testing is based on a set of assumptions about the future cashflows arising if we were to write the business. Once the business has been written and some experience has unfolded we can look at the VNB. The VNB calculation will consider the profitability of writing the business from the "point of sale". In effect there will be more certainty surrounding some of the assumptions in the VNB calculation (e.g., the mix and volume of business written, as well as the actual initial expenses), because some experience has unfolded. The assumed cost of capital will be included in the NPV calculation at the profit testing stage, and the actual cost of capital can be used in the VNB calculation.

The VNB can be compared to the NPV calculated at the profit testing stage to check that our profitability is developing as we expected.

And if I am wrong, I'd love to be corrected.

I hope this helps :)
 
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