Embedded value

[p_0910]

Hi, can you please explain the difference between surplus arising and embedded value profit during the year? Question 2 from April 2008 asks for the embedded value profit, and while I understand the calculation of EV profit, I am unclear on how this is different to surplus arising.

 

[varsha.agarwal2001@gmail.]

Hi, as per my understanding,
"Surplus arising" is based on entire portfolio to capture the high-level impact of economic and non-economic variances and assumption impact- where surplus is excess of change in assets minus change in liabilities over a given period. This surplus gives overall confidence in valuation process if all components are making sense while doing roll-forwards. This surplus is at entity level- helps to quantify difference between actual and expected scenario and needs to be distributed to both policyholders and shareholders at some point of time in future. (in case of WP).
Whereas Embedded value is the separate metric to quantify shareholder's profitability and potential profits held in existing business for future years via margins. Hence EV profit arising during the year is based on separate projections for shareholder's cashflows and profits analyzed at risk discount rate to enable shareholders place value on existing business and distribute dividends.

 

[p_0910]

Thank you, that's helpful! So if the definition of assets and liabilities was the same in the two cases (e.g., supervisory), and if the embedded value projection also has the same assumptions - would this mean that Embedded Value and Surplus arising during the year are the same if this is only without-profits business?

 

[Em Francis]

The presentation will be different as the change in the Embedded value will equal a change in net assets plus a change in PVIF, whereas an analysis of surplus will be a change in net assets only.

 

[CAKABOGU23]

The presentation will be different as the change in the Embedded value will equal a change in net assets plus a change in PVIF, whereas an analysis of surplus will be a change in net assets only.

Don't know if my question is altogether different but here goes:
Say IFRS4 is the reporting framework and valuation profits are recognised on day one. Retained Earnings and consequently, Net assets, would account for this valuation profits.
It seems to me a double count (with the exception of capital cash flows which were not included in the valuation profits) to then add PVIF.
In subsequent reporting periods, impact of revisions of methods/ assumptions flow through the income statement and adjust the NAV so in my head I'm thinking the NAV holds the value of future profits already.
To summarise my question, what profit does the PVIF report that the NAV doesn't?

 

[Em Francis]

Hi
Can we define the reporting regime you are referring to?
The NAV will need to be defined, ie is this the market value of assets less prudent liabilities?
If so, the PVIF is the present value of the release of prudent margins in the valuation basis, ie released as experience turns out to be better than expected.
If assumptions are revised then both the NAV and PVIF will change.

 

[Lindsay Smitherman]

Hi - just to add to the above, there's a couple of things to be careful with here.

EV starts from the supervisory valuation balance sheet. IFRS relates to profit reporting in a company's accounts, not to supervisory valuations.

And IFRS 4 would not necessarily recognise all profits on day one. In the UK, liabilities under IFRS 4 did contain some margin for prudence - thus delaying the emergence of some of the profit (ie those margins).

So, if we were to have a situation where the supervisory liabilities were the same as those used for IFRS 4 reporting, the PVIF would represent the present value of the expected future release of those prudential margins.

 

[Frederic Le]

Don't know if my question is altogether different but here goes:
Say IFRS4 is the reporting framework and valuation profits are recognised on day one. Retained Earnings and consequently, Net assets, would account for this valuation profits.
It seems to me a double count (with the exception of capital cash flows which were not included in the valuation profits) to then add PVIF.
In subsequent reporting periods, impact of revisions of methods/ assumptions flow through the income statement and adjust the NAV so in my head I'm thinking the NAV holds the value of future profits already.
To summarise my question, what profit does the PVIF report that the NAV doesn't?

Whatever profit already recognised would take away from the future expected profit, so there is no double counting.