Solvency II and EV

One of the things that is not clear to me is how will one compute appraisal value / embedded value of a life insurer once Solvency II is implemented.
What will be the VIF of the in-force book?

Surely, the old EEV method will be obsolete then (except of course those who would want to use this during transition phase).

Anyone can throw some light on this?

 

The best estimate liability (BEL) would be a proxy for the appraisal value. Under SII, best estimate assumptions are used which will mean a zero VIF.
Reserves (with prescribed margins + discretionery margins) - VIF = BEL

 

Thanks.

I don't know but something doesn't feel right. Why should VIF be zero?
I would have thought VIF = - BEL!

On a separate note, I didn't get why you wrote: "Reserves (with prescribed margins + discretionary margins) - VIF = BEL". I do not understand the rationale of computing reserves with margins under Solvency II.

 

Can anyone from ActEd respond?

 

Hi

1. Stat reserves (best estimate assumptions plus margins) = BEL + VIF. Firms expect the amount calculated as BEL to be sufficient to pay claims and expenses on their central scenario. This will leave VIF as profit.

2. BEL = Reserves (best estimte) and VIF = profits so the two are not the same. In Solvency 2, firms take credit for VIF implicitly by being able to hold BEL directly on the balance sheet (so it's a presentational thing to increase transparency among others).

3. Under Solvency II the reserves are market consistent and there are no prudential margins held (whilst firms are required to hold a risk margin this is to get the reserves to a market consistent level & therefore serves a different purpose compared to the current Solvency 1 Peak 1 regime).

4. Ref your original question, different insurers are adopting various approaches. Some may stop producing EV disclosures when S2 kicks in (I'm aware of one firm who has indicated this). I suspect once IFRS Phase II finally kicks it, the need to produce EV results will stop altogether as it is designed to more accurately value long-term insurance business compared to current accounting rules, which doesn't but those in reporting may have more insight

 

Thanks, mugono.

Whatever you said makes sense. But I think I still haven't got the answer to my real question.

Under Solvency II, we know stat reserves or technical provisions will be BEL + RM. So, the question of computing another stat reserves using BE assumptions plus prudent margins will not arise.

Now, thinking of someone thinking of acquiring an European life insurer post 2016, will I be wrong if I say that a fair value they would pay will be Own Funds (= Assets less Technical Provisions) + Goodwill?

In other words, OF will represent what we refer to as EV now!!

 

The Solvency II balance sheet is what regulators will use for assessing a firm's solvency and so focuses on policyholder protection. EV is from the eyes of shareholders and so the two are for very different purposes.

If I was going to acquire an insurer (or another other company) I would be interested in quantifying the firm's intrinsic value (this by definition is subjective). The Solvency II own funds COULD form a starting point but there would almost certainly need to be adjustments to allow for management's view where there is difference of interpretations with regulation. For example, a different interpretation of the contract boundary definitions for the purpose of calculating technical provisions for SII.

There will be a number of considerations (qualitative and quantitative) a potential bidder would want to consider in deriving a firm's intrinsic value.

 

Thanks.

Yes, I do understand Solvency II balance sheet is for solvency purposes whilst a potential investor will be more looking at the shareholder cash-flows. Also, I agree there will be further considerations.

But what I was after is if the Solvency II can be leveraged and be treated as a starting point. Unlike now, one pretty much needs a separate set of computations.

 

I suspect you're placing too much emphasis on a 'holy grail'. No such things exists. Investors/analysts etc are likely to use what they understand as the starting point. Remember, you should (theoretically at least) get to the same answer irrespective of the starting point.

If I was a private equity firm I would probably start with the firm's IFRS accounts (as I would any other business/industry) and then make adjustments for nuances related to the firm/industry. So for example, I may decide to make an assessment for an insurer's future cash-flows of their in-force business etc.

The reason for the use of embedded value is due to the failings of IFRS reporting. The weaknesses surrounding IFRS is well known/understood and IFRS 4 Phase II is in the process of correcting for this. This will remove the need (in my view) of EV.