Hi, I have read the setting assumption chapters. However, I am confusing. Embedded value is a more realistic assessment of the value of an issuer. However, calculating Embedded value will use supervisiory reserve. Using supervisiory reserve means prudential, hence not realistic. Anyone can explain that? thanks
I think your logic is a little flawed. Supervisory reserves have to be held. Because they are prudent, each year on the realistic projection basis, experience will be better than expected, and this value will be released as profit. For example, if you expect to pay 5000 in claims on a prudent basis, and you end up paying 4000 on realistic basis, 1000 will contribute towards the EV.
Ev So, to take CannonRee's example further: Let's suppose the only business we have is a cohort of one-year term assurances, where the benefit is payable at the end of year of death. Suppose our current prudent reserves are 5000, but realistically we expect to have to pay out 4200 in one year's time, which has a current value of 4000 (discounting at 5% pa). Suppose out total assets are 5500, being 5000 in reserves and 500 free surplus assets. Our EV = PVIF + FS (present value of in-force business + free surplus) PVIF = (5000 x 1.05 - 4200) / 1.05 = 1000 ie the present value of "projected assets - projected claims" So EV = 1000 + 500 = 1500 We've used realistic assumptions to project the assets and estimate future claim amounts, but we've also used prudent assumptions to work out our current reserves. If we had longer term business, we'd be working out our prudent reserves for each future year, to see what release of reserves is expected and the sum the present value of all these releases to get our PVIF component.
